Are stablecoins ready for payments?

US lawmakers are working on legislation to make payments using stablecoins more widespread. Ousmène Jacques Mandeng, a Visiting Fellow at the London School of Economics and Political Science and a Senior Advisor at Accenture, writes that the viability of stablecoins in payments will depend on the existence of clearing that would allow them to work in inter-bank transactions.

Stablecoins have recently gained significant attention. The new US administration is promoting their use. In Congress, new stablecoin regulation is advancing rapidly. Stablecoins emerged as the preferred payment instrument in blockchain-enabled ecosystems. But they mostly operate in closed loops. To matter, they will need to adapt to open loop applications through generalised clearing as a foundation for scalability in payments.

The increase in volumes of stablecoins has been considerable but values remain small in total payments. The stock of stablecoins is about US$210 billion at end-February, up from US$140 billion in the same period last year, while monthly global transaction values increased by 50 per cent over the past 12 months to US$710 billion (Visa).

This compares to about US$810 billion (US, 2022) and US$300 billion (euro area, 2023)  of monthly average card transaction values. In the American and European large value payment systems, US$91,000 billion (US Fedwire) and US$35,000 billion (euro area T2) were processed monthly in 2023.

Stablecoins are digital monies issued on blockchains to offer a payment instrument fixed to the national currency at par (1:1) for blockchain-enabled payments. They exhibit advanced functionalities like programmability and traceability. They are technically equivalent to a fixed exchange rate. To ensure convertibility at par, stablecoin issuers usually maintain a reserve or backing portfolio. Similar to other par instruments, stablecoins are vulnerable to runs.

The transfer of a stablecoin can be rapid, usually providing low cost, easy access and high levels of convenience. However, the essential advantages of stablecoins rest mostly on operating closed loop applications.

Monies can be transferred in closed and open loops. In closed loops, monies move between two persons, both sharing the same institution or payment system, representing simple book-entry-like adjustments. Transactions that involve persons at two different institutions (open loops) require the institutions to clear. Funds are transferred normally between banks in the domestic large value payment system or in cross-border transactions through nostro accounts with correspondent banks.

Most closed loop systems can offer fast and seamless transactions. The real challenge in payments arises in open loops. They require clearing arrangements by which financial institutions accept monies from other institutions. The biggest obstacle to money transfers is not the technical transfer but counterparty and credit risks, liquidity and compliance. To allow stablecoins to be used to conduct payments more generally, there needs to be clearing arrangements between stablecoins and banks.

In domestic payments, where a stablecoin is transferred to a payee who is not on-boarded by the stablecoin issuer, the stablecoin payer normally needs the bank of the payee to accept the stablecoin. This implies an off ramp by the stablecoin issuer by redeeming the stablecoin and transferring the proceeds to the payee bank or through a clearing agent who accepts the stablecoin and makes an equivalent fund transfer to the payee bank.

In cross-border payments, stablecoins would have to be cleared by the foreign bank as a foreign currency claim. As in cross-border payments, there is normally no fund transfer and payments clear through nostro-vostro account relationships between banks, the foreign payee bank may retain the stablecoin or seek redemption via a correspondent bank with an equivalent claim through its nostro account.

To be eligible for clearing by banks, the stablecoin issuers need to represent acceptable counterparty and credit risks and the operations should not give rise to undue principal and settlement risks. Regulation and the prudential treatment of stablecoins will need to ensure they do not pose excessive costs for banks in terms of risk mitigating measures, including regulatory capital and liquidity buffers.

If stablecoins were accepted as collateral in finance operations of central banks and banks, it would significantly enhance their attractiveness in open loop operations. Any institution that accepts the stablecoin would have to be on-boarded by the stablecoin issuer to observe critical compliance provisions.

Banks are advancing plans to issue tokenised deposits, bank deposits issued on blockchain, leveraging existing bank networks. Asset managers are working on issuing tokenised money market fund shares to offer very high-grade payment instruments to target large value payments. Both are economically equivalent to stablecoins and offer significant advantages over stablecoins, representing relatively familiar instruments and exhibiting broader network effects.

It is not clear stablecoins can offer sufficient differentiation from other blockchain-enabled par instruments. They also tend to be more expensive to hold as they are typically non-interest bearing. In cross-border payments, the absence of fund transfers could make stablecoins highly competitive relative to ordinary bank nostro claims. Regulation should be sufficiently harmonised to establish a level playing field across instruments with similar economic characteristics.

The viability of stablecoins will depend on its efficient operation in open loop applications. Whether they become a core payment instrument or remain niche will be an outcome in large part of their ability to bridge the gap between crypto ecosystems and the banking system.