Stablecoin are in the spotlight due to their rapid growth, increasing global use cases and potential financial risk contagion channels. To date, the speed and cost of stablecoin transactions, as well as their redemption terms and conditions, have fallen short of what is required of practical means of payment in the real economy. Their growth, innovation and increasing use cases, coupled with their potential contagion channels to the financial sector, call for the urgent implementation of effective regulatory, supervisory and oversight frameworks before significant further interconnectedness with the traditional financial system occurs.

Introduction

Stablecoin are a segment of the wider crypto-asset ecosystem along with what is often referred to as unbacked crypto-assets. They were developed to address the high price fluctuations of unbacked crypto-assets such as bitcoin and ether, and their comparatively low price volatility predestines Stablecoin for a number of functions where this property is needed.

Stabilization tools include reserve assets against which stablecoin holdings can be redeemed, as used by so-called collateralised Stablecoin, and algorithms that match supply and demand to maintain a stable value, as used by so-called algorithmic Stablecoin

The function of Stablecoin inside the crypto asset ecosystem

The uses of Stablecoin within the crypto-asset ecosystem have multiplied in recent years. Initially, Stablecoin was mainly used as a relatively safe “parking space” for crypto volatility and as a bridge to trade crypto-assets. But with the rise of decentralized finance (DeFi) applications, Stablecoin has gained new uses.

Stablecoin accounts for only a small part of the total crypto-asset market, but the largest ones have assumed a critical role within the crypto-asset ecosystem. Their market capitalisation decreased $29.5 billion from Jan, 2021 to just $138.4 billion as of January 31, 2023. Stablecoin only accounts for below 10% of the total crypto-asset market. However, they have become a critical part of the crypto-asset ecosystem due to their frequent use in the trading of crypto-assets and as liquidity providers in DeFi. This holds specifically for Stablecoin dominating the market.

Stablecoin provided around 45% of the liquidity in decentralized exchanges (DEXes) in 2022 (By the data from European Central Bank). About half of this amount was provided by collateralized Stablecoin. As we can see from the data, stablecoin’s usage in DeFi is quite important.

Stablecoin as a form of payment

Payment service providers are not very active in stablecoin markets and offer limited stablecoin payment services. One reason for this lack of activity could be regulatory uncertainty pending the adoption of the Markets in Crypto-assets (MiCA) Regulation.

Transaction speeds as measured by the confirmation time for an average transaction vary by blockchain and depend inter alia on the consensus mechanism used. Other factors such as the block time and size, transaction fees and network traffic also influence transaction speeds. However, the transaction time is not near-instant or real-time as required for usage at the physical point of sale or in e-commerce..

Another reason is the fee of transactions. Stablecoin transaction costs vary, and for many Stablecoin, fees are higher than ATM or card scheme costs. Moving to new blockchain technologies like PoS or PoH can increase speed, scalability, and reduce costs, but there may be trade-offs. The largest Stablecoin limit redemption options, with constrained access to redeem at par value to the official currency. Public disclosure about redemption terms is often insufficient, and consumer protection measures may not apply to Stablecoin. These factors impact the attractiveness of Stablecoin for end users, making it essential to consider their specific features and costs compared to traditional payment systems.

Potential risks of Stablecoin adoption

Stablecoin, while offering benefits as digital currencies, also pose potential risks to financial stability through contagion channels and their interplay with unbacked crypto-assets.

A critical aspect for Stablecoin is the management of their reserve assets. Collateralized Stablecoin must ensure robust reserve asset management to instill confidence, maintain the peg, and prevent potential runs on the coin. Proper management underpins users' confidence in Stablecoin, but a loss of trust could trigger large-scale redemption requests, leading to negative contagion effects on the financial system.

Transparency regarding reserve asset composition has improved, but detailed information remains scarce, hindering a clear view of liquidity and potential contagion effects for short-term funding markets.

Recent developments have exposed the vulnerability of Stablecoin to instability. For instance, the crash of TerraUSD and the temporary de-pegging of Tether demonstrated that Stablecoin are not infallible. Differences between Stablecoin in terms of redemption possibilities and reserve composition transparency may have played a role in these events.

Holders of Stablecoin may face losses in the event of a run on or failure of a stablecoin. Large investors hold the majority of some Stablecoin, with retail investors representing a small percentage. Data gaps make it challenging to identify these large investors, but anecdotal evidence suggests they may be specialized institutional investors, thereby limiting spillovers to the broader financial system.

The growing interest from banks, payment service providers, and big tech companies in Stablecoin could increase connections with the traditional financial system, potentially raising concerns about financial stability.

Considering the critical function Stablecoin play in the broader crypto-asset ecosystem, the nature and scale of crypto-asset markets' evolution could pose risks to financial stability in the future, particularly if unbacked crypto-assets continue to grow.

Regulations for Stablecoin

International standards should cover all entities and functions in stablecoin arrangements, considering the complex nature of Stablecoin involving multiple entities across various sectors and jurisdictions. Existing sectoral standards may leave gaps in addressing stablecoin risks due to their emergence after these standards were designed.

Given the rapid growth of the stablecoin market, urgent implementation of regulatory measures is necessary. The EU's introduction of MiCA Regulation leads international efforts, providing a harmonized framework for Stablecoin and crypto-assets. This regulation subjects stablecoin issuers and service providers to a set of minimum requirements regardless of their licensing regime, with additional requirements for addressing specific risks related to stablecoin issuance.

Differentiating between stablecoin types according to the risks they pose is crucial, as demonstrated by recent events around TerraUSD. Algorithmic Stablecoin should be treated as unbacked crypto-assets, recognizing the risk associated with their collateral or lack thereof.

Conclusion

In conclusion, Stablecoin has emerged as a significant part of the crypto-asset ecosystem, offering stability and various use cases. However, their rapid growth and increasing integration with DeFi raise concerns about potential financial risks. Urgent and robust global regulatory frameworks are necessary to address these risks and ensure stability before further connections with the traditional financial system.

Challenges remain for Stablecoin as a means of payment due to transaction speeds and costs, coupled with regulatory uncertainties affecting broader adoption. Recent incidents have highlighted the vulnerability of Stablecoin to instability, emphasizing the need for proper reserve asset management and transparency.

About VNST

VNST is a decentralized stablecoin with transparent on-chain data, guaranteed by the stable value of the most popular and reputable stable coins in the global crypto asset market. The stablecoins that ensure value for VNST have transaction volume and stability proven over a long period of time, issued by reputable organizations with proven potential and periodically audited. VNST will be a safe, reliable solution, providing diverse and convenient choices and expanding future applications for users in the Web3 field in Vietnam and around the world.

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