The State of the Stablecoin as a Payment Mechanism

For years, crypto has had its adherents and investors. But it was never truly taken seriously by the traditional financial sector and its composite institutions, the U.S. regulatory desert aside.

As evidenced by a Monday (Jan. 13) report from the Federal Reserve Bank of Atlanta, stablecoins, increasingly heralded as the bridge between traditional finance and the cryptocurrency world, have started to change that dynamic.

“The future of stablecoins as a payment method is still unfolding, but as digital assets gain wider acceptance, their adoption could grow, potentially rivaling credit or debit cards,” that report said, noting that the stablecoin market value is “comparable to the gross domestic product of countries like New Zealand or Greece,” while retailers such as Overstock, Chipotle, Whole Foods and GameStop now accept them.

In recent news, Tether, the crypto firm behind the world’s most widely used stablecoin, USDT, announced Monday it would be moving its headquarters to El Salvador.

Unlike the usual crypto rollercoaster of value volatility, stablecoins bring an alleged dose of stability to the digital currency game, while at the same time being able to function as a store of value, a medium of exchange and a unit of account.

The growing embrace of blockchain within financial services and payments is reflected in the strong interest among traditional financial firms, with Bank of America holding over 80 blockchain-related patents, and its multinational peers such as HSBC, Barclays, J.P. Morgan Chase, UBS and others currently participating in stablecoin-centric banking pilots. 

Understanding what stablecoins are, how they’re minted, issued and used, as well as the differences between the many different varieties out there, is crucial to enterprise enablement and adoption of the novel asset as a both payment mechanism and store of value.

Read more: Blockchain Interoperability Hits the Right Note for Crypto Payments

Fiat currencies such as the U.S. dollar and the euro are the backbone of global commerce, issued and controlled by central banks and governments. These authorities not only provide stability but also establish and oversee the financial rails these currencies ride on. While this centralized system ensures reliability and broad utility, it also imposes strict limitations on access and usage.

Stablecoins are meant to mimic the stability of fiat by pegging their value to a reserve asset, such as fiat currency, commodities or even other cryptocurrencies, while offering greater interoperability across financial systems.

“This isn’t about replacing existing systems. It’s about providing an additional option. Where stablecoins offer superior benefits, customers will naturally gravitate toward them,” Miles Paschini, CEO at FV Bank, told PYMNTS.

“As more banks integrate blockchain capabilities, customers will have greater choice in transferring value,” he added. “We’re blazing the trail for a future where blockchain is just another payment rail.”

While stablecoins have yet to prove themselves as a ubiquitous payment mechanism, their use is growing, and the infrastructure supporting them continues to mature.

Read more: Stablecoin Sandwiches? Here’s What CFOs Need to Know About Crypto Jargon

Stablecoins come into existence through a meticulous process of minting and issuance, one that typically involves creating new tokens pegged to a stable asset, such as a fiat currency, a basket of assets or commodities like gold. The minting process varies depending on the type of stablecoin — centralized or decentralized — but the general concept is to ensure that the stablecoin is backed by collateral and can be redeemed for the equivalent value in the underlying asset.

Centralized stablecoins, like USDC (USD Coin) and USDT (Tether), are issued by central entities (like Circle or Tether). The minting process for these stablecoins is both straightforward as well as largely dependent on the trust in the issuing entity.

The minting process begins when a user deposits fiat currency (e.g., USD) with the company that issues the stablecoin. For example, a user might deposit $1,000 into the issuer’s bank account or reserve. Once the collateral is received, the issuer mints an equivalent amount of stablecoins. So, if a user deposits $1,000, they will receive 1,000 USDC (since USDC is pegged 1:1 with the U.S. dollar).

The issuing company then holds the fiat currency in reserves and may keep these reserves in a bank account, money market funds or other low-risk financial instruments. When a user wishes to redeem their stablecoins, they can return them to the issuer, who then “burns” the stablecoins (removes them from circulation) and sends the equivalent fiat back to the user. For instance, if a user returns 1,000 USDC, they’ll get $1,000 back.

Issuers mint stablecoins onto various blockchains to leverage the unique features that different blockchains offer. Blockchains can generally be categorized as either third-party (public) or first-party (private). A third-party blockchain, like Ethereum, is an open and decentralized blockchain used by many participants and developers to build applications, whereas a first-party blockchain, such as Ripple (XRP Ledger), is typically controlled or maintained by a single entity or a smaller group of stakeholders, often focused on specific use cases like cross-border payments.

Different blockchains offer distinct features, allowing stablecoins to be issued in ways that best meet the needs of issuers and users. By understanding the nuances of stablecoins — from their creation to their application — enterprises can position themselves at the forefront of the digital economy.

PYMNTS Intelligence found that using cryptocurrencies for cross-border payments could be the winning use case that the sector has been looking for. The research found that blockchain-based cross-border solutions, particularly stablecoins, are being embraced by firms looking to find a better way to transact and expand internationally.

The post The State of the Stablecoin as a Payment Mechanism appeared first on PYMNTS.com.