This digital currency could build a more sustainable global economy

This article is brought to you thanks to the collaboration of The European Sting with the World Economic Forum. Author: John Liu, chief product officer, Fusion Foundation & Peter Lyons, Senior Adviser, Emerging Technologies, Lapa Capital

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Whether we are talking about trade and investment or banking and payments, stablecoins and the technology underlying them will be the building blocks of a more sustainable, inclusive, and resilient global financial system. This will require not only interoperability across blockchains, but also interoperability between fiat cash and digital currencies, and between centralized and decentralized systems.

A stablecoin is a cryptographically signed digital asset recorded on a blockchain, usually backed by some ‘real-world’ asset such as a fiat currency or commodity. This is intended to provide price stability, so that the stablecoin can be used as a digital store of value and/or medium of exchange.

One of the major ways in which stablecoins could contribute towards a more resilient global economy is by tempering some of the potential threats posed by the US dollar’s (USD) domination of global foreign currency reserves.

Foreign currency reserves are often accumulated by countries through trade and play an important role for central banks in stabilizing the value of their national currency. According to the IMF, the US dollar (USD) accounted for 62% of all foreign reserves held by central banks in the first quarter of 2019, while US GDP accounted for 15% of global GDP.

USD reserves are usually held by central banks in the form of US government bonds, and are thus removed from circulation. This relentless flow of USD into US government bonds has kept US interest rates lower for longer and pushed the country’s debt and GDP to levels not seen since the Second World War. A global scarcity of USD creates major headwinds for US exporters, widening the trade deficit and pressuring economic growth.

As we saw during the 2008 global financial crisis, a major political or economic disturbance can drive investors headlong into USD-denominated ‘safe assets’ and create a global liquidity crunch. Without another massive round of quantitative easing, a flight into USD could quickly drain remaining global liquidity and cause cascading effects across the global financial system.

In August 2019, Bank of England governor Mark Carney gave a speech at a gathering of central bankers in Jackson Hole, Wyoming. He argued for reducing global reliance on the USD as the international reserve currency by creating a global digital reserve asset backed by a basket of leading currencies (including the USD, the euro, the British pound and the yen). According to Carney, a diversified digital currency – one only partially weighted in USD – could unlock dollar funds stockpiled by governments and help increase global liquidity, trade and investment.

It turns out that a framework for a diversified international reserve currency has been around for 50 years, in the form of the IMF’s Special Drawing Right (SDR). The SDR’s value is maintained as a weighted combination of the world’s leading currencies.

In addition to diversifying sources of global liquidity and helping to balance trade flows, stablecoins could also boost financial inclusion by reducing the global poor’s dependence on physical cash. One-in-three adults worldwide does not have a bank account, most of whom live on a few dollars per day and do not meet minimum account balance requirements. This problem is compounded by the limited reach of physical banking infrastructure around the world. Holding, managing and transacting in cash imposes significant logistical, financial and security burdens on the unbanked. Even when bank accounts are opened, minimum account balances are held and transaction activity is kept to a minimum to avoid incurring banking fees. For most banks, the world’s 1.7 billion unbanked adults are not the highest priority.

The billions more who are underbanked might hold a minimum account balance but continue to rely on cash for transactions. Minimum account balances and limited transaction data, combined with personal income volatility, mean most banks simply do not have enough data to provide financial services to lower-income account holders. This is not just a developing world problem; according to a 2017 survey by the Federal Deposit Insurance Corporation, 25% of US households – more than 50 million adults – are unbanked or underbanked.

In the developing world, banks usually have limited access to credit reporting services and often require higher levels of collateral (and higher interest rates) to hedge against lending uncertainty. To tackle this global credit gap, a wave of fintechs have emerged that analyze clues from a prospective borrower’s digital footprint to forecast expected volatility and the likelihood of repayment. Stablecoins could expand the reach of consumer and small business credit across borders by reducing exposure to foreign exchange risk and the high fees associated with international payment networks.

International remittances are the single largest source of external financing for many of the world’s low and middle-income countries. International remittance typically involves an archaic patchwork of correspondent banks, post offices and money transfer agents that usually pocket 7-10% of the total value of each transaction. International remittances using stablecoins and their distributed ledgers could eliminate the need for costly intermediaries, allowing for lower fees and immediate settlement.

Reducing remittance transaction costs to 3% by 2030 is a target under Sustainable Development Goal 10, and if successful could constitute what would be, in effect, a huge tax cut for the world’s poor.

To-date there are over 200 stablecoins operating across a number of different blockchains and protocols. Private organizations have led the way in launching stablecoins with USD-backed coins like Tether, USDCoin, and Gemini Dollar the most active. Some governments are catching up, including Dubai with emCash, Singapore with Ubin, and the People’s Bank of China with Digital Currency Electronic Payment (DCEP) project.

Perhaps the best known of all stablecoins is one that has not even launched. In June 2019, Facebook announced the creation of the Libra Association which would (sometime in 2020) launch a new “global currency and financial infrastructure to empower billions of people.” With the 2.7 billion active monthly users across Facebook’s platforms, Libra stands out from the hundreds of other stablecoin projects for the speed with which it could reach global scale as a payment system.

To reduce the risk of any single stablecoin becoming systemically dominant (and simply replacing a fiat hegemon with a digital one), there should be an emphasis on interoperability and frictionless exchange across blockchains. Blockchain interoperability can increase economic and transactional scalability, speed and security.