Stablecoins and the New Payment Landscape

DAOSquare
2024-08-08 19:04:52
Collection
  • In 2023, stablecoins settled transactions worth $10.8 trillion, of which $2.3 trillion was related to organic activities such as payments and cross-border remittances.

  • Today's payment giants face significant disadvantages, including high transaction costs, slow settlement times, and limited transparency, although stablecoins also have their advantages.

Introduction

Currently, global payment infrastructure is being modernized and improved, providing users with faster and cheaper payment options. Stablecoins are increasingly being used to build robust crypto payment systems, facilitate remittance payments, and simplify cross-border transactions. In 2023, the total transaction volume settled by stablecoins exceeded $10.8 trillion—excluding "non-organic" transactions, such as those by bots or automated trading, the figure is $2.3 trillion. On an adjusted basis, transaction volume grew by 17% year-over-year, indicating that stablecoins are rapidly catching up to today's largest existing payment networks.

Despite the existing payment networks enjoying significant advantages in liquidity and network effects, competition has intensified, and according to the World Bank, the average cost of remittance payments has decreased by more than one-third over the past 15 years. However, the average cost of sending $200 globally remains at 6.35% of the remittance amount, totaling about $54 billion in fees annually. In contrast, the average transaction cost for remittances using stablecoins is much lower, ranging from 0.5% to 3.0%, and there is potential for further cost reductions due to ongoing innovations in technology.

As technology makes it easier for merchants and users to adopt new payment methods, existing payment networks are becoming more susceptible to challenges from fintech disruptors. Integrating stablecoins into existing payment systems is an example of how cryptocurrencies are increasingly being applied in the real economy. However, we believe that to expand the role of stablecoins, some of the technical complexities of blockchain need to be simplified, and clearer regulations are required to ensure consumer protection and promote broader financial inclusion.

Future King?

Recently, stablecoins have become a hot topic, especially after the Markets in Crypto-Assets Regulation (MiCA) came into effect in Europe on June 30. USDC became the first dollar-pegged stablecoin in the region to comply with MiCA standards, while Circle's euro stablecoin EURC also met MiCA compliance requirements. Traditional financial institutions are also deploying stablecoins in the region or planning to do so. This includes the digital asset division of Société Générale, Forge, which launched an institutional version of the EURCV stablecoin, and DWS, the asset management team of Deutsche Bank, which manages about €1 trillion (approximately $1.09 trillion) in assets and plans to launch a new euro stablecoin in 2025.

These developments could have a significant impact on efforts to establish a digital payment network within Europe. Other jurisdictions are also preparing their own stablecoin regulatory frameworks, such as Hong Kong, which will draft relevant legislation after the public consultation period ends. Meanwhile, the U.S. is working to establish rules in this area, with both the House of Representatives and the Senate having related bills. Former House Speaker Paul Ryan noted in a Wall Street Journal op-ed that stablecoins could help maintain the dollar's dominance while addressing the growing national debt issue. Former Comptroller of the Currency Brian Brooks (who previously served as Coinbase's Chief Legal Officer) echoed similar sentiments, stating in the Wall Street Journal that stablecoins help maintain the dollar's status as the world's reserve currency.

Thus, stablecoins have become an important new tool for enhancing existing global payment systems. In 2023 alone, the flow of funds involved in cross-border commercial transactions, international business (retail), and global remittances reached an astonishing $45 trillion. (See Figure 1) As these markets continue to grow, estimates by the International Fund for Agricultural Development, FXC Intelligence, and Statista suggest that this amount could rise to $76 trillion by 2030. Today, the traditional infrastructure handling such vast cross-border financial flows faces many inefficiencies, which increase costs and slow down the speed of cross-border fund movement.

Immediate Union

The existing payment landscape consists of various entities, which we broadly categorize into four main types. While many of these participants represent existing systems, some are striving to embrace (or at least attempt) the integration of stablecoins into their existing workflows. The four main categories include:

  • Automated Clearing Houses: Representing electronic networks used for processing bank transfers and other financial transactions (primarily domestically or within sovereign borders),

  • Major Credit Card Networks: Such as Visa, Mastercard, and American Express in the U.S., or UnionPay in China,

  • International Banking Payment Networks: Such as the Society for Worldwide Interbank Financial Telecommunication (SWIFT) and the Cross-Border Interbank Payment System (CIPS),

  • Mobile Payment Systems: Such as PayPal/Venmo in the U.S., Alipay (and WeChat Pay) in China, and the Unified Payments Interface (UPI) in India, which provide digital payment solutions and peer-to-peer (P2P) transactions.

It is worth noting that although the Fedwire funds transfer system settled $1.09 quadrillion in 2023, we exclude it from our list because the network primarily serves members of the Federal Reserve System, including large banks, corporations, and U.S. government agencies. It mainly settles large and time-sensitive transfers in real-time and does not handle small retail payments or remittances, which is the primary focus of this report.

Analysis

Electronic networks, such as the ACH (Automated Clearing House) in the U.S. or SEPA (Single Euro Payments Area) in the Eurozone, are among the largest payment systems on our list. In many countries, these systems help facilitate interbank fund transfers among domestic financial institutions on a large scale. They typically include direct deposits and bill payments, but in recent years, many systems have also added peer-to-peer (P2P) and business-to-business (B2B) transactions.

According to Nacha (formerly the National Automated Clearing House Association), in 2023, the ACH network in the U.S. settled $80.1 trillion in transactions, a 4% increase from the previous year. Historically, ACH transactions settled within 1-2 business days, but increasingly, same-day settlement options are being offered. It is important to note that China also has a credit card payment processing system called UnionPay, which operates a large interbank network in China. UnionPay's interbank payment system processed ¥279.5 trillion (approximately $39.5 trillion) in transactions in 2023.

At the same time, credit cards rank high on our "payment dominance" list, as they are deeply ingrained in the spending habits of many consumers, especially in developed countries. In many places, the credit card borrowing process has been simplified, and users often receive attractive sign-up bonuses. However, these payment giants can charge retailers fees of up to 3.5%, which are increasingly passed directly to consumers. Additionally, users may pay an average interest cost of 20% annual percentage rate (APR) on unpaid credit card debt (in the U.S.).

In cross-border transactions, credit card companies often charge users an additional 1% international fee, making these payment entities very profitable for overseas spending. Visa reported in its 2023 annual report that it processed $12.3 trillion in payment transaction volume last year (ending September 2023), excluding $2.5 trillion in cash withdrawal transactions, while Mastercard reported in its 2023 annual report that its total dollar transaction volume was $9.0 trillion.

Traditional banking payment networks like SWIFT and CIPS currently dominate the interbank cross-border payment space, with remittances typically conducted through these networks. SWIFT is a secure messaging platform connecting over 11,000 financial institutions across more than 200 countries. However, unlike automated clearing houses, SWIFT does not settle (transfer funds).

These networks are used solely for sending and receiving secure messages, providing each party with transaction details that need to be confirmed and allowing them to update their respective ledgers. CIPS was launched by the People's Bank of China in 2015 to compete with SWIFT and improve the efficiency of cross-border RMB transactions. Over the years, SWIFT and CIPS have jointly supported most of the cross-border payments between global financial institutions.

Finally, mobile payment systems are the newest entrants, offering domestic and international peer-to-peer (P2P) transactions. Convenience is one of their biggest advantages, as they often provide a more user-friendly interface for transfers compared to traditional banking methods. Some mobile payment systems also integrate social media components. Mobile payments are typically real-time, which is a major advantage for both senders and receivers, as it reduces the risk of chargebacks. However, P2P payments only appear to be instantaneous, as they often exist within a closed ecosystem, meaning such transactions are merely adjustments to the vendor's ledger.

However, the downside is that these systems often require pre-existing banking relationships and/or credit cards to function, meaning users still rely on traditional financial systems. This poses a barrier for low-income individuals who may not have access to such services. Mobile platforms may also collect vast amounts of personal and financial data, raising privacy concerns.

Decentralized Lightweight Presence

These traditional systems have established most of the processing networks and infrastructure for global transaction volumes. However, they also have some significant drawbacks, such as high transaction costs, slow settlement times, and limited transparency. For example, bank transfers involve multiple intermediaries. In contrast, stablecoins operate on public blockchains, relying on transparent processes to prevent fraud and resolve disputes in a decentralized manner through consensus. This is often cheaper, faster, and easier to trace.

Of course, using stablecoins also comes with trade-offs. For instance, stablecoins operate on blockchains, providing nearly instantaneous settlement, but this makes it difficult to reverse fraudulent transactions. The proliferation of multiple blockchains may also lead to fragmented liquidity for stablecoins, potentially exposing users to costs and risks when bridging from one chain to another. Finally, the user experience (UX) of cryptocurrencies can be cumbersome and overly complex for the average user. The good news is that this complexity has begun to be gradually abstracted through smart wallets and payer architectures (which shift gas fees from users to decentralized applications). Nevertheless, we expect it may take years for users to fully adapt to these systems and use stablecoins end-to-end.

Meanwhile, existing systems still enjoy significant advantages, such as considerable transaction volumes stemming from a large user base. That is, network effects are crucial, as it is easier to send and receive payments on platforms that already have a large number of users. A report by McKinsey indicates that banks have an advantage over fintech companies in maintaining consumer trust. For stablecoins to gain widespread acceptance, not only must regulatory issues be addressed (see the "Killer Application" section below), but user trust must also be established.

Fortunately, technology has lowered the costs for users and merchants to adopt new payment methods. This has made traditional payment giants more susceptible to challenges from fintech disruptors. In fact, according to the World Bank, competition has reduced the average cost of remittance payments by more than one-third over the past 15 years. (See Figure 3) Recent tests by the Bank for International Settlements indicate that tokenization can facilitate faster and safer cross-border transactions. However, the average cost of sending $200 in cross-border remittances remains at 6.35% of the remittance amount, totaling about $54 billion in annual fees.

In contrast, the average transaction cost for remittances using stablecoins is much lower, ranging from 0.5% to 3.0%. The broadness of this range reflects that while the direct costs of transferring stablecoins on some networks (like Ethereum Layer-2) may be very low, there may be other costs involved. For example, converting local fiat currency to stablecoins or vice versa may incur exchange and/or conversion fees when the platform provides the service. However, as network scale and/or adoption rates increase, this could also lower future fees by increasing transaction volumes and reducing the per-transaction costs for providers. Therefore, the overall costs of stablecoin transactions may continue to optimize.

Filtering Noise

Stablecoins are often referred to as the "killer application of cryptocurrencies" due to their potential for mainstream commercial applications and comparative advantages over traditional payment rails (such as speed and cost). This label aims to express the promise of stablecoins attracting a broader consumer base to use blockchain technology.

However, the reality is that the primary use case for stablecoins today is to allow crypto investors to trade digital assets between centralized and decentralized exchanges. This is also why the market capitalization of stablecoins is often used as a proxy indicator for liquidity in the digital asset market, as its growth corresponds to increased depth and price stability in the broader crypto market. In the $10.8 trillion transactions settled by stablecoins in 2023, the majority of transaction volume is often used for trading purposes.

To take a more conservative approach, we filtered the total transaction volume based on criteria listed in a blog post published by Visa in April 2024—this post was a response to Nic Carter of Castle Island Ventures. They argued that stablecoin transaction data may contain noise due to "non-organic activity and other artificial inflationary behaviors." Therefore, they "adjusted" stablecoin transaction volume by (1) removing duplicate transactions in smart contract activity and (2) filtering out bot-driven and automated transactions. For the latter, they only included transactions from accounts that initiated fewer than 1,000 stablecoin transactions and transferred less than $10 million within 30 days.

It is important to note that Visa's on-chain analytics dashboard only publishes 30-day data, making comparisons with other payment systems challenging. Therefore, we undertook the laborious task of applying their criteria to filter stablecoin transaction data over the past five years in hopes of gaining valuable insights. In 2023 alone, we found that stablecoins still settled over $2.3 trillion in "organic" transactions annually, which may still include trading but is more focused on payments, P2P transfers, and remittances. For example, within this adjusted amount, cross-border B2B transactions on the blockchain accounted for only $843 million, but Statista predicts this will increase to $1.2 billion in 2024.

These adjusted transaction volumes grew by 18% in 2022 and by 17% in 2023. This growth rate is faster than any of the aforementioned payment systems and exceeds the absolute volume of PayPal's payments. In fact, even after adjusting for "non-organic activity," the transaction volume processed by stablecoins last year accounted for about one-fifth of Visa's payment volume and over one-quarter of Mastercard's, representing significant growth since the inception of stablecoins. Notably, as of now, the adjusted stablecoin transaction volume is approximately $1.7 trillion (about 10% of total stablecoin transaction volume), compared to $1.3 trillion in the first seven months of last year—organic activity has increased by 28%, with growth continuing to accelerate.

Killer Application

Despite the enormous transaction volume associated with stablecoins, the market capitalization in this space remains relatively modest at $164 billion, although it has grown by 26% since the beginning of the year. (See Figure 6.) Nevertheless, stablecoins currently account for only 7% of the $2.3 trillion market capitalization of the crypto market. Some market analysts speculate that the stablecoin market could grow to nearly $3 trillion within the next five years. While this figure may seem high, as it approaches the current size of the entire crypto market, we believe it remains within the realm of possibility when considering that this number would only represent 14% of the U.S. M2 money supply ($21 trillion) (currently at 0.8%).

The biggest obstacle to achieving these predictions remains regulation. As early as 2020, the Financial Stability Board (FSB) published a set of "high-level recommendations for the regulation, supervision, and oversight of global stablecoin arrangements" (the final report was released in July 2023), which was conducted under the G20's mandate. These recommendations are shaping the development of stablecoin regulation in many jurisdictions. In fact, MiCA has already legalized the issuance of stablecoins in Europe, based on its stringent rules and operational guidelines. In Asia, several places either already have stablecoin frameworks, such as Singapore and Japan, or plan to launch them soon, such as Hong Kong. Nevertheless, consistent cross-border regulation could enhance user confidence and lead to a more predictable overall market environment.

In the U.S., there are currently two pending bills in the House and Senate: the "2023 Payment Stablecoin Clarification Act" (CPSA23) and the "Lummis-Gillibrand Payment Stablecoin Act" (LGPSA). While both bills stipulate specific reserve requirements for stablecoin issuers and include broad consumer protection provisions, they differ in their specific regulatory approaches. CPSA23 mandates that stablecoin issuers be regulated by appropriate federal or state authorities, while LGPSA provides for a comprehensive federal regulatory framework. More specifically, LGPSA sets a cap of $1 billion for stablecoins issued by non-depository trust companies, with entities exceeding this amount required to register and obtain approval from deposit-taking institutions, with regulation more akin to that of banks.

Conclusion

As the payment landscape continues to evolve, traditional banking systems, credit cards, and even mobile payments face greater pressure to adapt to changing customer needs. Stablecoins aim to connect the volatile world of cryptocurrencies with traditional finance by maintaining price stability (primarily pegged to the dollar). However, these tokens have only begun to be used on a large scale for low-cost fund transfers in the past 2-3 years, despite the field being formally launched in 2015. While there are some key comparative advantages in speed and cost over existing systems, stablecoins still need to integrate with the existing financial system to promote their use in everyday transactions.

We believe stablecoins represent the next significant leap in payments and capital flows, especially as merchants and other entities find it increasingly easier to integrate this technology into their economic workflows—indeed, even compared to a few years ago. Recently, Coinbase announced a partnership with payment provider Stripe to offer USDC for cryptocurrency payments on Base and for fiat-to-crypto conversions; in addition, Visa, Mastercard, and PayPal have all launched their own stablecoin initiatives in recent years. Other notable mentions include Shift4, Nuvei, Worldpay, and Checkout.com. That said, stablecoins need clearer regulations and a smoother cryptocurrency user experience to firmly establish the foundation of their potential.

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