Long Thesis #1: Stablecoins Are The Future of Money (Part 1/2)

The crisis of confidence in stablecoins in the wake of Terra’s collapse does not mean that they are a fundamentally worthless idea, or impossible to execute well.

Our long thesis is that stablecoins are likely to become a fundamental building block of a modern financial system.

We explain what stablecoins are, and what makes them fundamentally better than existing systems of money.

In a follow-up article, we will explain why stablecoins offer a compelling alternative, even when compared to online payments, mobile bank wallets, and CBDCs.

What Are Stablecoins?

Stablecoins are blockchain-based currencies that aim to achieve a pegged exchange rate to fiat currencies.

There are various mechanisms designed to achieve this peg. Each with varying degrees of success, and exposed to different types of risks. But we’ll also leave that discussion for another article.

Why Stablecoins Are The Future of Money

Our long thesis is based on the conception that stablecoins are: (i) internet-native, and (ii) programmable money. These two traits make them a potentially faster, cheaper, and better way of storing and transferring value.

This is true especially for cross-border payments, where the poor interoperability of banks’ systems hits users hardest. While the value propositions of stablecoins for domestic payments is less evident today, stablecoins can help emerging economies to leapfrog gaps in domestic payments today that run on banks’ infrastructure.

Internet-native Money

As internet natives, we’ve grown to assume that global, instant, transfers of data are the norm. We can send a text message, forward a video link, share a document or folder with anyone, at any time, anywhere in the world. Today, we can do the same with our money, thanks to stablecoins.

Like other types of data on the internet, stablecoins exist on a global blockchain ledger, maintained by a global network of validators. In contrast, traditional money exists in separate physical vaults or digital ledgers managed by thousands of different banks, with systems running on different standards and formats that were not designed to be interoperable. A report by Visa provides an excellent explanation of the various knots in the tangled mess we rely on today to transfer over $156 trillion in cross-border payments each year.

Then there’s SWIFT (Society for Worldwide Interbank Financial Telecommunications): an industry-owned limited liability cooperative that supplies secure messaging services and interface software for financial transactions to more than 7,650 banks, securities brokers and investment managers in more than 200 countries. SWIFT provides the messaging infrastructure for most electronic cross-border payments today.

Which all sounds terribly impressive, until you read SWIFT’s own diagnosis of the dysfunctions that plague this critical backbone of our global economy. Earlier in February, Mireia Guisado Parra, Pre-validation Product Owner at SWIFT reported on the results of an internal study analysing payment exceptions on the SWIFT network. “We found that 72% were the result of formatting errors, account issues and invalid data”, wrote Parra.

A research study by Accuity estimated that in 2020, failed payments cost the global economy $118.5 billion. The same study reported that most organisations are subject to a payment failure rate of 5% or less. Shockingly, nearly a fifth (18%) report a failure rate of 5–10%.

Speaking to the human cost of these inefficiencies, SWIFT’s own report noted that payment failures “…stop shopkeepers from getting the supplies they need on time, impact international supply chains and prevent loved ones from receiving the funds they need, when they need them”.

And in exchange for all that, the cost of accessing SWIFT makes blockchain network gas fees seem paltry by comparison. A report published in 2019 by Deloitte found that corporates seeking to connect to SWIFT on their own can expect to pay between:

• 15,000 EUR to 20,000 EUR in one-time installation costs covering the software, hardware and integration
• 6,000 to 15,000 EUR in annual recurring fees for after sales support from SWIFT, and
• 2,040 EUR annually for their messaging traffic sent via SWIFT

Nearly half, or 46 percent of corporates prefer to rely instead on third party connectivity service bureaus to access SWIFT. Deloitte found that this method would cost between 20,000 EUR to 40,000 EUR for on-boarding, and 15,000 EUR to 35,000 EUR in annual fees.

The cost of accessing SWIFT is hardly “accessible”, considering that the 86.3% of small business owners in the United States make less than $100,000 a year in income, according to the Small Business Administration. By comparison, accessing and using internet-native money like stablecoins costs nearly nothing — something we have come to expect of most of our internet activity.

Digital money has existed for decades within the banking system. In fact, physical cash currently only accounts for anywhere between 10–20% of GDP, particularly in advanced economies. But what makes stablecoins different is that they exist on a common, global ledger, rather than on siloed bank ledgers.

Thousands of banks globally operate on non-standard customer interfaces, incompatible formats between domestic and foreign banks, and the low degree of automation in banks’ internal systems. To the extent that banking systems today seem interoperable, it is thanks only to a patchwork of cumbersome, costly workarounds to cover the inefficiencies of legacy technology stacks. Upgrading existing banking systems is slow because it is expensive and risky. There aren’t enough incentives for any one existing player to change a cumbersome system — one with few alternatives, until now.

When Satoshi released the Bitcoin white paper in 2008, he explained: “A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution”.

Unlike bank-based money, paying with stablecoins is nearly instantaneous even on weekends or holidays, and can cost fractions of what banks or card processing companies typically charge. This is especially critical for cross-border payments. Payments are the enabler for global commerce, and labour markets, and our increasingly global and digital economy needs internet-native payment rails.

But while cross-border payments are the lowest-hanging fruit, stablecoins can also offer a superior alternative to domestic payment rails. Particularly in countries where domestic banking infrastructure is underdeveloped, large segments of the population are either unbanked or underbanked.

Stablecoins can address financial inclusion, because using them for retail payments requires no significant investments in physical infrastructure like bank branches, ATMs, or even POS terminals. With little more than an internet connection and mobile device, anyone can begin to send and receive stablecoin payments.

Just as the internet brought the world of information into the pockets of over 5 billion users, stablecoins can do the same for financial services.

Programmable Money

Perhaps more importantly, stablecoins are programmable money. Today, there’s almost always an app for just about anything. That’s because programmability allows anyone to develop tools to automate our lives. Like schedule sending emails, recommending movies we might like to watch, aggregating and sorting hotel room listings, or pulling meeting and flight schedules from our email inboxes into our calendars.

Similarly, stablecoins can interact with smart contracts, allowing us to create interesting ways to automate traditional financial services, ranging from escrow, to lending, securities exchanges, credit scoring and more. Such services can be made cheaper, faster, and more accessible than they could ever be on traditional banking rails.

Developing such services on traditional banking and payment rails is either prohibitively costly, or in some cases impossible to do. For example, it took the National Payment Corporation of India (NPCI) four years post-launch to incorporate recurring payments for UPI, which is the underlying infrastructure that powers bank-to-bank payments in India. Fintech players like Google Pay who were reliant on UPI, could not support use cases like YouTube or Play subscriptions until the upgrade to UPI was introduced.

In contrast, the inherent programmability of stablecoins enables the easy deployment of automated, recurring, and real-time payments. For instance, Superfluid is working with Request Finance to allow enterprises to manage payroll and billing in continuous streams. In just a few clicks, service providers, or employees can get paid on a daily basis, rather than monthly. In contrast, setting up standing orders or direct debits today often requires manual processes like filing physical paperwork with a bank.

Programmability lowers the barriers to innovation and competition in financial services. Where traditional banks must operate on costly and complex systems and processes, many small teams of entrepreneurial talent have already been developing self-executing Decentralized Finance (DeFi) protocols that can perform critical functions of banks; namely, connecting savers to borrowers.

The programmability of stablecoins means that banks could well go the way of the ATM, as cheaper, more scalable DeFi protocols replace today’s labour-intensive, highly manual banking operations. In the Global Financial Stability Report published in April 2022, the International Monetary Fund (IMF) estimated that the overall cost structure of traditional financial institutions is between 3–7 times that of DeFi platforms. Being able to provide faster, more reliable banking and payment services at a dramatically lower cost will be a radical enabler for the emergence of a new age of global commerce.

With these defining traits of stablecoins in mind, we now compare stablecoins to existing payment solutions that have been built on top of traditional banking and payment rails.

Read Part 2 here. (Coming Soon)