What are the common misconceptions about payment giants betting on stablecoins?

Author: Christian Catalini

Compiled by: Shenchao TechFlow

Stripe Inc., headquartered in South San Francisco, California, on Tuesday, April 16, 2024.

Stripe recently acquired the stablecoin orchestration startup Bridge, which has caused a significant stir in the cryptocurrency world. This marks the first time a major payment company has invested over a billion dollars to advance this technology. While this is not Stripe's first foray into the cryptocurrency space, the timing feels particularly different. Currently, there is unprecedented enthusiasm for stablecoins, and Bridge's co-founder Zach Abrams has successfully shaped the company into the "Stripe of the cryptocurrency world," catching the attention of the Collison brothers.

Many may not have noticed that while Bridge is valued at $1.1 billion for Stripe, it may not have reached that valuation on its own. This is not due to a lack of capability from the team—Zach and his team have assembled a group of top engineers—but rather because profitability in the stablecoin space is extremely challenging. Whether it’s issuance, orchestration (i.e., converting between different stablecoins), or integration with traditional banking systems, achieving long-term profitability is a significant challenge.

So why is this the case? After all, Circle and Tether have made substantial profits in the past two years amid rising interest rates, and as expectations for Circle's public listing continue to grow, the market seems ready for further growth and integration.

However, the reality is that the network effects of the stablecoin market may not be as strong as anticipated, and it is not a "winner-takes-all" scenario. In fact, stablecoins may simply be loss-leading products that could even become loss-making projects without necessary supplementary assets. While industry insiders often argue that liquidity is the main reason only a few stablecoins can dominate, the reality is much more complex.

What are some common misconceptions about stablecoins? Let’s delve deeper.

CEO of Tether Holdings Ltd. Paolo Ardoino

Photographer: Nathan Laine/Bloomberg© 2023 Bloomberg Finance LP

1. Stablecoins Need a Supporting Business Model

When we designed Libra, we realized that for stablecoins to succeed, they must rely on a supporting business model. The Libra ecosystem was built around a nonprofit association that brought together wallets, merchants, and digital platforms to support the issuance and payment network of stablecoins.

Relying solely on reserve interest to achieve profitability for stablecoins is not sustainable. We recognized this early on when planning to issue stablecoins backed by low-interest (like the euro) or even negative-interest (like the yen) assets. Companies like Circle and Tether seem to overlook that the current high-interest environment is merely a temporary anomaly, and a sustainable business model cannot be built on a foundation that may change quickly.

Of course, stablecoins can profit not only through "stock" but also through "flow." Circle recently raised redemption fees, indicating they are beginning to recognize this. However, this practice contradicts a fundamental principle in the payments space: to earn user trust and loyalty, the movement of funds should be seamless. While exit fees may be acceptable in the gaming industry, such fees undermine the basic expectation of free movement of funds in mainstream payments. Therefore, transaction fees could become a potential revenue source, but implementing these fees on the blockchain without strict control protocols is quite challenging. Even so, it is impossible to charge fees for transactions between users within the same wallet provider. These are scenarios we explored in depth during the Libra project, revealing the complexity and uncertainty of the nonprofit association business model.

So how should stablecoin issuers choose? Unless they rely on temporary regulatory loopholes—unlikely to last long (which will be discussed in the next section)—they need to start competing with their own customers.

A recent series of initiatives by Circle, including the launch of programmable wallets, cross-chain protocols, and the Mint program, clearly shows the company's direction. However, this is not good news for many of its closely related partners. This situation is not uncommon in platform strategies: never let partners intrude between you and your customers. Yet many exchanges and payment companies have made this mistake by incorporating Circle into their ecosystems. To survive, Circle must transform into a payment company, even if it means encroaching on allies' markets. This model is not new—think of Amazon's relationship with third-party sellers, travel platforms with hotel chains, or Facebook with news publishers. When platforms succeed, they often absorb functionalities that originally relied on partners and profit from the effective parts. Developers in the Apple and Google ecosystems are all too familiar with this.

Stripe does not face such a dilemma. As one of the world's most successful payment companies, they have mastered how to build and profit from a streamlined software layer on top of global capital flows—this model scales efficiently through network effects without relying on country-specific banking licenses. Stablecoins accelerate this process by bridging Stripe with domestic banks and payment networks, allowing networks previously constrained by traditional institutions (like card companies) to overcome last-mile issues, providing greater value to merchants and consumers.

This is why PayPal launched its own stablecoin, and other fintech giants like Revolut and Robinhood are following suit. Unlike before, they are beginning to compete on open protocols but can enhance their core businesses by adjusting their stablecoin strategies. In doing so, they will make stablecoins extremely cheap and convenient for consumers and businesses.

On Tuesday, September 26, 2023, Argentine peso bills equivalent to $1,000 are organized in Buenos Aires, Argentina

© 2023 Bloomberg Finance LP

2. Dollarization is Not a Product

The cryptocurrency space has severely underestimated the impact of regulation on its future. We experienced this when releasing the first version of the Libra white paper, which led to two years of difficult regulatory dialogues to ensure the project met the expectations of policymakers and regulators.

Today's stablecoins face the same situation. Many believe that stablecoins can seamlessly provide consumers and businesses with low-cost global dollar accounts. After all, during times of crisis, people around the world want to hold dollars in a "too big to fail" American financial institution. Moreover, some may think that the U.S. government would support this trend, as it helps solidify the dollar's status as the global reserve currency.

However, the reality is much more complex. While the U.S. would face significant losses if it lost its financial and sanctions infrastructure as the global standard—especially if the dollar's "excessive privilege" is weakened like previous reserve currencies—the U.S. Treasury may not always support accelerated dollarization. In fact, its Office of International Affairs may view this as a significant challenge to foreign relations and global financial stability.

Countries that value monetary policy independence, worry about capital flight during crises, and prioritize domestic bank stability will strongly oppose the widespread adoption of frictionless dollar stablecoin accounts. They will use all means to prevent or restrict these accounts, just as they resist other forms of dollarization. While a complete ban on crypto trading may be unrealistic, as shown by the development of the internet, governments still have various ways to limit access and suppress its mainstream application.

Does this mean that stablecoins will face difficulties in emerging economies with capital controls or concerns about capital flight? Not necessarily—the rise of domestic stablecoins that adhere to local banking and regulatory frameworks is an inevitable trend. Although the dollar has historically dominated the stablecoin market, the situation could change rapidly. In Europe, with the implementation of the Markets in Crypto-Assets (MiCA) regulation, banks, fintech companies, and emerging enterprises are racing to issue euro-denominated stablecoins. This strategy helps maintain the stability of local banking systems and will become increasingly important in regions like Latin America, Africa, and Asia.

Clear regulations also enable banks to compete in a fair environment, which has not yet been realized in the U.S. In addition to issuing fully backed stablecoins, banks can also issue deposit tokens to increase earnings through money creation. This places pure stablecoin issuers without banking licenses, discount windows, or government deposit insurance at a significant competitive disadvantage.

In Hong Kong, various payment service icons are displayed

Photographer: Anthony … [+]© 2016 Bloomberg Finance LP

3. There Will Not Be a Single Stablecoin Winner

Indeed, issuers can build network effects around the global liquidity and availability of their stablecoins, but as decentralized exchange (DEX) protocols know, liquidity can be easily gained and easily lost. Similarly, economies of scale in branding and marketing may help issuers capture market share, but this does not always translate into a truly sustainable competitive advantage.

The reality is that the core characteristic of stablecoins—anchoring to currencies like the dollar or euro—is also their greatest weakness. Currently, these assets are viewed as independent entities, but once regulations standardize safety across all stablecoins, individuals and businesses will regard them as ordinary dollars or euros. While there are indeed legal distinctions—evident in the Silicon Valley Bank run—most people do not care whether their dollars are held in a U.S. bank or JPMorgan. This is the magic of the dollar as a currency, all driven by the Federal Reserve behind the scenes.

Stablecoins will undergo a similar process. Although there may be dozens of stablecoins in each major market, users will overlook these complexities. Once this happens, the economics of stablecoins will favor companies with complementary business models or those that control the interfaces between stablecoins and their supporting assets (like bank deposits, U.S. Treasury bonds, or money market funds).

This is bad news for pure stablecoin issuers like Circle, as their banking system interfaces rely on companies like BlackRock and BNY Mellon. These financial giants may become direct competitors. For example, BlackRock is already operating the world's largest tokenized U.S. Treasury and repo fund (BUIDL).

A common misconception in the history of technological disruption is that existing companies often successfully fend off challenges. Even the classic case of disruptive innovation mentioned by Clayton Christensen—the rise of small disk drive manufacturers in the hard drive industry—is not entirely accurate: Seagate not only survived the disruption but remains the largest manufacturer globally. In highly regulated industries like financial services, new entrants face even greater challenges.

Tech companies with banking licenses, such as Revolut, Monzo, and Nubank, have already secured advantageous positions in the market, and others may accelerate their licensing efforts to gain similar advantages. However, many participants in the stablecoin market will struggle to compete with traditional banks and may face the risk of being acquired or failing. Banks and credit card companies will resist a market dominated by a few stablecoins, preferring to support a market landscape composed of multiple interoperable and interchangeable issuers. When this occurs, liquidity and availability will be driven by existing consumer and merchant distribution channels, which is precisely the advantage that new banks and payment companies like Stripe and Adyen possess.

Fully backed stablecoins like USDC and USDT need to find high-frequency use cases, such as cross-border capital flows, to maintain their market position or attract a decentralized finance (DeFi) ecosystem that can introduce transparent scoring to support their narrow banking model. Meanwhile, deposit tokens or tokenized funds issued by banks will gain broader adoption due to their stronger economic foundations, especially at the consumer and institutional levels. Institutional users are particularly accustomed to managing diversified assets, such as money market funds, and are very concerned about the opportunity cost of their capital. In this area, competition for stablecoin yield sharing has already begun.

In every region, whether banks or cryptocurrency companies, there will be efforts to become the key gateway to local markets. However, they need to seriously consider how stablecoins can lower the barriers for foreign competitors to enter the market by connecting local payment systems with blockchain networks. After all, from a business perspective, the core change is that these systems will operate based on open protocols.

General Manager of the Bank for International Settlements Agustin Carstens

Photographer: Vernon … [+] Yuen/NurPhoto from Getty Images

So What Does All This Mean?

For leading payment companies, fintech firms, and emerging banks, the outlook is bright. They can leverage stablecoins to streamline operations and accelerate global expansion. This also creates new opportunities for domestic stablecoin issuers to elevate their status and prepare for the global interoperability of payment systems—in this area, stablecoins are expected to succeed, while the Bank for International Settlements' "financial internet" vision may be difficult to realize.

Leading cryptocurrency exchanges will also leverage stablecoins to more actively enter the consumer and merchant payment space, becoming strong competitors to major fintech and payment companies.

Although questions remain about how stablecoins will expand anti-money laundering and compliance controls during their proliferation, there is no doubt that they provide opportunities to rapidly modernize the financial services system and change the industry leadership landscape.