Forget bitcoin, card firms should embrace stablecoin payments - Gartner
Research house Gartner has poured cold water on Visa’s recent move to support bitcoin trading on its network, arguing that the real revolution in payments would see centralised financial companies support stablecoin transactions on blockchains.
Earlier this week Visa outlined plans for the first pilot of its new suite of crypto APIs, following other industry players such as PayPal and Square in embracing the digital currency movement.
Gartner analyst Avivah Litan says that the move is welcome, and increase the “technical rails between consumers, businesses and blockchains, and help prepare the transition to future payment infrastructure”.
However, in a blog, she also notes that it is “hardly a revolution”. Having centralised financial companies that earn revenues by charging transaction fees at the centre of crypto goes against the peer-to-peer ideals of blockchain payments.
“Potential users are left to wonder if, in the future, they will have to pay these centralised services additional transaction fees for moving cryptocurrency across peer-to-peer blockchain networks, defeating the promise of blockchain,” writes Litan.
Her answer to this problem is for card brands and other established players to provide the on and off ramps for payors and payees using stablecoins, without being involved in the actual payment that would occur on the blockchain.
This would mean Visa and its peers would not get a transaction fee but would make money from issuers and acquirers using services such as risk management, onboarding and protections for balances.
Concludes Litan: “The question remains: will these centralised financial services companies go forward in line with the spirit of blockchain peer to peer payments at the risk of cannibalizing their existing central-clearing house based-revenue streams? The answer will depend on whether or not these firms have any practical choice.”
Credit Card Companies Should Offer Stablecoin Payments or Be Left Behind: Gartner
Centralized payment companies such as Visa, Mastercard and PayPal will need to adapt if they are to survive the potential demand for blockchain-based stablecoin payments, according to research firm Gartner.
In a Thursday blog post, Gartner notes that, while new bitcoin (BTC) offerings from such firms are helping to prepare the transition to a future payment infrastructure, their revenue is based on charging transaction fees for clearing and settlement.
The fee strategy, which sit at odds with blockchain’s peer-to-peer model, could be the very thing that sees these firms fall behind the competition from stablecoin payment networks, per the post penned by Avivah Litan, distinguished VP analyst at Gartner.
Litan described such firms as “centralized decentralized finance” (CeDeFi) – in which centralized, mainstream firms with big bitcoin holdings bring innovation to the DeFi space and, conversely, adopt DeFi’s biggest apps.
But Litan points out that customers of these types of services are likely wondering if they will be obliged to pay centralized service fees for moving their cryptocurrency along the blockchain in the near future, defeating the technology’s initial promise.
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“Companies we speak to are justifiably skeptical of these services,” Litan wrote. “After all, the revolution of blockchain payments is that they execute peer-to-peer and eliminate central intermediaries and associated bank fees.”
However, the author added Gartner has yet to see a range of offerings from the crypto space for viable stablecoin payments, pointing to a lack of easily accessible applications and fees lower than are currently on offer from card networks or firms like Square and PayPal.
Litan said there’s potential for card firms to provide a range of as-yet-unseen offerings, such as transparent real-time stablecoin payments on the blockchain tied to underlying information regarding a given transaction, and protections for funds backing stablecoin sitting in partner bank accounts.
Card companies could provide the gateways for payors and payees and add functionality, according to the post.
“The card brands could still earn revenues from on and off ramp value-added services, and from interest on the reserves underlying the stablecoins,” Litan said.
By 2022, CeDeFi could be ready for enterprise adoption if the regulatory guidance is present, the research analyst predicted.
But, should the legacy payment companies fail to keep pace with the likes of fiat on/off ramps, such as fast-moving cryptocurrency exchanges like Binance and Gemini, other firms are going to step forward.
Frances Coppola: Stablecoins Rely on Shadow Banking
We often talk about central banks creating fiat money. In fact, most fiat money is not created by central banks but by commercial banks. Furthermore, not all of the banks that create and hold fiat money are regulated banks. Many are what we know as “shadow banks.” In the cryptocurrency network, there is a whole shadow banking industry creating and holding fiat money, or something that looks very much like it.
Shadow banks are financial institutions that do bank-like things but aren’t subject to banking regulations. They include investment banks, non-bank lenders, money market funds, private equity and hedge funds, and insurance companies. They also include special purpose vehicles (SPVs), which are subsidiary companies created by regulated banks to enable them to do unregulated things. And they include banks headquartered outside the U.S., notably those in offshore jurisdictions.
Frances Coppola, a CoinDesk columnist, is a freelance writer and speaker on banking, finance and economics. Her book “The Case for People’s Quantitative Easing,” explains how modern money creation and quantitative easing work, and advocates “helicopter money” to help economies out of recession.
The “shadow dollars” created and held by shadow banks are known as eurodollars. “Euro” here doesn’t refer to the euro currency and doesn’t have much to do with Europe. Eurodollars nowadays tend to live in places like the Cayman Islands and the Bahamas.
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Because eurodollars are held outside the U.S. regulated banking system, they do not have FDIC insurance and the institutions in which they are held have no backing from the U.S. Federal Reserve. Really, they are “faux dollars.”
To their users, however, eurodollars are indistinguishable from real dollars created by the Fed and U.S. regulated banks. And when eurodollars flow from the shadow banking system into the regulated system, they become real dollars. Conversely, dollars created by the Fed and regulated U.S. banks become eurodollars when they are sent to offshore or foreign locations. The system works as long as the 1:1 implied exchange rate between eurodollars and real dollars holds. But when the peg fails, there is chaos.
Tether’s bank, Deltec, is part of the shadow banking network. It is located in the Bahamas, an offshore jurisdiction beyond the reach of U.S. regulation, and it holds U.S. dollar deposits. Deltec Bank is not backed by the Federal Reserve, and the U.S. dollars it holds have no FDIC insurance. So Tether’s deposits in Deltec Bank, including the cash reserves that Tether says back USDT tokens, are eurodollar deposits.
Deltec Bank might hold cash reserves in one or more U.S. regulated banks. But these reserves may not be sufficient to back all of its eurodollar deposits. And even if they are, dollars in regulated bank deposit accounts are not “in custody.” They are loaned to the bank and only insured up to the FDIC limit of $250,000 per customer per institution. Anyway, FDIC insurance only applies to deposits in regulated banks, not to deposits in offshore shadow banks, even if those shadow banks are customers of the regulated banks. If Deltec Bank failed, there would be no FDIC insurance for its depositors. Tether’s guarantee that 1 USDT = 1 USD therefore entirely depends on Deltec Bank remaining solvent.
See also: Pascal Hügli – Hyper-Stablecoinization: From Eurodollars to Crypto-Dollars
It’s not just Tether that relies on shadow banks. In a recent interview, Tether’s chief technical officer, Paolo Ardoino, said that not only Tether itself but the cryptocurrency exchanges that are its principal customers have U.S. dollar accounts at Deltec Bank.
Some of these exchanges might use Deltec Bank as their settlement bank. But others might simply have accounts at Deltec to make paying for Tethers more convenient. Instead of wiring U.S. dollars to Deltec Bank every time they need to top up their tethers, they can simply fund their Deltec account whenever it suits them and use the balance to pay for more tethers. But whichever approach they use, the money they keep on deposit at Deltec Bank is not FDIC insured and not backed by the Fed. And if their own settlement banks are also shadow banks, then any money they have with those is not FDIC insured or Fed-backed either.
The collapse of the money market fund Reserve Primary … shows how disastrous the breaking of an implied exchange rate peg like this can be.
Not only do Tether and its crypto exchange customers rely on the fiat shadow banking network, they are themselves part of it. And other stablecoin issuers are, too. Just as Tether guarantees that 1 USDT = 1 USD, other stablecoin issuers similarly guarantee that their coins are equivalent to U.S. dollars. They even call them U.S. dollars: USDT means “USD tether,” USDC means “USD coin,” and so on. But stablecoins are, with few exceptions, created by unregulated financial institutions that have no FDIC insurance and no Fed backing. Really, stablecoins are “faux dollars.”
See also: Frances Coppola – The Stablecoin Surge Is Built on Smoke and Mirrors
Whether stablecoins like USDT and USDC can be exchanged 1:1 for U.S. dollars depends entirely on the existence of adequate U.S. dollar reserves and on the solvency of the banks that hold those reserves. If there aren’t enough actual dollars to pay all those who want to withdraw their funds, the 1:1 exchange rate peg will break and coin holders won’t be able to get all of their money back.
The collapse of the money market fund Reserve Primary during the 2008 financial crisis shows how disastrous the breaking of an implied exchange rate peg like this can be. Investors in a money market fund pay dollars in return for shares in the fund. Until 2008, money market funds marketed themselves as high-interest versions of insured U.S. bank deposits. There was a widespread belief that shareholders would always be able withdraw what they put in, that no fund would “break the buck.” So, 1 share = 1 USD. Sounds rather similar to a stablecoin, doesn’t it?
Reserve Primary MMF didn’t have 100% cash reserves backing its shares. It had invested in commercial paper issued by, among others, the shadow bank Lehman Brothers. When Lehman Brothers failed in September 2008, the value of its commercial paper crashed to zero and Reserve Primary MMF could no longer guarantee the 1:1 peg. It announced to its shareholders that it could only return 97 cents for every dollar they had invested.
Reserve Primary MMF’s announcement, hard on the heels of the failure of Lehman Brothers and the collapse of the insurance company AIG, sent shockwaves through the financial system. Massive amounts of money ran from the shadow banking network into regulated banks and U.S. Treasurys. To stop the run, the Fed bailed out the shadow banking network, reinstating the broken peg and restoring confidence in eurodollars.
See also: JP Koning – What Tether Means When It Says It’s ‘Regulated’
Like Reserve Primary MMF’s shareholders, cryptocurrency traders treat stablecoins as simply a variety of U.S. dollar. Of course, traders know the exchange rate is not guaranteed, and not all stablecoin issuers have 100% cash reserves. But, hey, the Fed bailed out shadow banks before, didn’t it? Why wouldn’t it bail out stablecoins?
Unfortunately for crypto traders, stablecoins and their banks are nowhere near as dangerous to the global financial system as Lehman Brothers, AIG, Reserve Primary MMF and the rest of the shadow banks that crashed in 2008. If Tether goes down, the crypto market will be seriously disrupted, but the rest of the world will hardly notice. And few people are going to lose any sleep over a small Bahamian bank failing.