Defining the characteristics of the ideal stablecoin
Stablecoins have made great strides since the first iterations BitUSD and Bubits were created back in 2014 and, as the name suggests, designed to be “stable” (i.e. not volatile) compared to other cryptocurrencies. They were created to have a return similar to the US$ and were backed by a basket of cryptocurrencies.
Today, Tether (USDT) is the largest stablecoin out of over 200 that now exists and is considered the world’s first true stablecoin that is predominately, but not exclusively, backed by US$ deposits. Stablecoins themselves have proved to be very profitable for the issuers, as can be seen by Coinbase, which reported $146million of income from its part ownership of USDC in Q4 2022. Even greater was the $1.44billion that Tether earned in the first quarter of 2023; the reason these stablecoins are generating so much income is that they typically do not pay the owners any share of the interest that is earned from the bank deposits and other collateral that backs these stablecoins.
PayPal recently introduced PYUSD, an Ethereum ERC20 stablecoin backed by the US dollar, in another sign that traditional fintech players still see an upside in digital assets and their underlying technology. It is available for select US users, with plans to roll the token out fully over the coming months.
One potential concern is that although some stablecoins have retained the service of major accountancy firms, they typically perform attestations on those coins instead of thoroughly auditing them.
As US accountants, IS Partners LLC, explain: “Audits are performed to discover data, risks, or compliance issues that may not have been known before the audit took place, and attestation is to evaluate and review how true the data or information is when compared to a stated purpose, internal control. The attestation engagement examines the issue to check if it truly falls outside the parameters of the compliance standard as an opinion is given about the compliance issue.”
Indeed, there are those who are very concerned about attestations: “Under any circumstance, an attestation is not the same thing as an audit — and this kind of “unverified snapshot” would never pass any sort of regulatory muster. Audits are methodically designed to look for potential risks, while attestations only evaluate whether the data being examined by the “attestator” is accurate at that precise moment in time. Hence, any iteration of attestation is pretty useless, especially as a matter of due diligence”, reports John Reed Stark Consulting LLC.
Meanwhile, and again in the US, the Public Company Accounting Oversight Board offers this caution: “Proof of reserve reports are inherently limited, and customers should exercise extreme caution when relying on them to conclude that there are sufficient assets to meet customer liabilities.”
With these issues, how could stablecoins provide potential mainstream users with confidence as a store of value and be usable? PayPal’s PYUSD will be an interesting test case, given it has brand recognition and consumer uptake. That’s one barrier down, but will people use it? This remains to be seen.
So, with those concerns in mind, is there an ‘ideal state’ model for these assets that could provide regulators with a level of comfort and help solidify them as an alternative payment method?
Events within the digital economy and the TradFi space have highlighted the importance of simplicity and transparency in minimising counterparty risk and protecting consumer wealth. We see the gold standard for stablecoins as being fully transparent over cash collateralisation, and where fiat reserves sit. Ideally, this would be a 1:1 dynamic with funds held at a fully regulated bank.
Stablecoins were originally developed to offer a haven for crypto investors during volatile times in the crypto markets. But as we increasingly see the digitisation of real-world assets such as equities, bonds, funds, real estate and even derivatives, we will need to have sound governance of these stablecoins if they are to be trusted and adopted as a method of payment.
So, what attributes would an ideal stablecoin ideally have?
- Correct name, pegged coin: in many ways, stablecoins are a misnomer; indeed, it would be better to call them ‘pegged’ and then be crystal clear as to what they are pegged to — £, €, $, gold, a basket of crypto or, in Tether’s case, a basket of assets that varies from time to time.
- Audits, not attestations: ensure a reputable third party confirms what assets are held and, where possible, have the third party offer a credit rating and ascertain whether any conflicts of interest exist with those who have any influence or control over the assets.
- Deployment of smart contracts: investors could see the assets in almost real-time. If they are less than, say, 99% not held where they ought to be, the smart contract notifies the investors and regulators directly.
- Income generating: a % of the income generated from the assets held should be paid to the holders.
- Transparency: everyone can see where the assets that back the stablecoin are invested. If a holder becomes under suspicion (e.g., for money laundering, terrorism, a politically exposed person, etc.), the stablecoins in question can be ring-fenced pending instructions from a relevant authority.
- Traceability: if a stablecoin is lost or stolen, then, once verified, the lost digital currency could be destroyed and replaced.
- Privacy: many people would prefer a third party does not know what they are spending, with whom, or on what, subject to appropriate controls (i.e., preserve the confidentiality/anonymity that cash currently offers) to avoid nefarious actors using stablecoins as their preferred choice of payment.
- Insured: ideally, any monies held in a stablecoin are insured up to twice the amount compared to monies held in a traditional bank account. This ought to encourage corporations to hold stablecoins since they would have more of their cash insured.
- User friendly: in the same way that many of us have both current and deposit accounts, banks could offer a current account, a deposit account and a digital account where stablecoins would be deposited, making it easy for users to switch between fiat and a digital currency.
Much like bank deposits, stablecoins do not need to be risky options for investors, but they can be, as was seen by the collapse of Silicon Valley Bank and the stablecoin Terra Luna. If designed correctly, stablecoins can be very secure and used as an alternative to cash and current banking arrangements.
We will probably see high-quality stablecoins being deployed in many jurisdictions and then carefully monitored by central bankers before we see widespread issuance of CBDCs (Central Bank Digital Currencies). We could almost see stablecoins being used as market research tools as governments and central bankers follow their progress, not to replace cash but to act as an alternative payment method before CBDCs are launched.
Iain Monk is the Digital Asset Strategy Lead at ClearBank. In this role, he examines new opportunities and the role the bank should play in the digital asset ecosystem as it evolves. Prior to this, Iain spent four years at Ripple creating and managing their global Rulebook for standardised cross-border payments across RippleNet and represented Ripple on the ISO20022 RMG.