The rise of stablecoins: Bridging traditional finance and digital assets

Key Takeaways

• The stablecoin market is on the rise, with market size projections ranging from $500 billion to $2 trillion by 2028.
• The introduction of regulatory frameworks such as the GENIUS Act and MiCA clarifies how stablecoins are issued, used, and reported, providing grounds for growth of the market.
• Stablecoins provide a new channel for banks to raise capital similar to traditional deposits, while providing an alternative to traditional payment channels.

With regulatory clarity being introduced worldwide, stablecoins are rapidly gaining traction as a bridge between traditional finance and the crypto world. Projections for the stablecoin market range from $500 billion (J.P. Morgan estimate) to $2 trillion (Standard Chartered estimate) by 2028.

This blog looks at how stablecoins are poised to move beyond an introductory step into the digital asset ecosystem and impact financial institutions across banks and payment providers. It also explores how banks and payment giants are exploring ways to adopt them.

What are stablecoins and how do they work?

A stablecoin is a kind of cryptocurrency whose value is ‘stable’ in relation to fiat currencies like the US dollar, making it a perfect introduction to digital assets while avoiding the typical volatility of cryptocurrencies like Bitcoin. Stablecoins are simple to use and can be used to process transactions rather seamlessly, regardless of geographic location, while providing the stability of a traditional asset (see J.P. Morgan report on stablecoin characteristics).

There are a few steps an issuer needs to take to create and issue a new stablecoin. In short, an issuer offers the digital tokens created as part of a ledger (that is, stablecoins) in exchange for their pegged value in fiat currency (for example, US dollars). Following the passing of the US Genius Act, any bank can issue these assets and exchange them for dollars, with the commitment that they will maintain the value paid for them in “high-quality liquid assets” (as per the US’s GENIUS Act definition). This provides the holder of the digital token (stablecoin) with guaranteed liquidity in converting their coins back to the notional amount paid in fiat currency.

For those looking for an introduction to the basics, Bank of England recently provided a decent introduction to stablecoin, which may be useful.

How can MiCA and the GENIUS Act be game-changers for stablecoin transactions?

Major regulatory or legislative changes often reshape markets. The GENIUS Act, along with the EU’s MiCA rules, show early signs of the type of regulations that tend to bring major shifts in the structure of existing or new markets.

GENIUS Act

Recently, the US Senate passed the Guiding and Establishing National Innovation for US Stablecoins Act (the GENIUS Act), which regulates how stablecoins are issued, used, and reported. The key provisions under the GENIUS Act include:

1. Only certain regulated institutions, such as banks, credit unions, subsidiaries of banks, and nonbank financial institutions that have approval from the Federal Reserve, can issue stablecoins.
2. Stablecoin issuers must hold 1:1 reserves for any coins issued. These reserves can be in physical currency, US Treasury bills (T-Bills), repurchase agreements (repos), and other low-risk assets approved by regulators. The issuers are required to disclose their reserve composition periodically and undergo routine audits.
3. All stablecoin issuers must have measures in place to prevent money laundering and financing of terrorism and ensure consumer protection.

MiCA

Under the EU’s Markets in Crypto-Assets (MiCA) regulation, stablecoin issuers are required to establish clear rules for redemption. Specifically, asset-referenced tokens (ARTs) and e-money tokens (EMTs) must have transparent redemption mechanisms in place, with issuers expected to maintain sufficient reserves to honor any redemption requests. Only regulated financial institutions are allowed to issue e-money tokens (EMTs), while asset-referenced tokens (ARTs) can only be issued by EU-based entities and authorized by regulators.

Yet there are some key differences:

1. Under the GENIUS Act, reserves must be tied to US assets like US Treasury securities (USTs), or dollars. In contrast, MiCA ensures that issuers hold a significant part of the reserves within the EU, for coins marketed inside its
2. The EU has a strict cap on the amount of non-Euro stablecoins that can be used. No such currency quota exists under the US’s GENIUS Act – although issues of USD-backed stablecoins are restricted by US regulatory supervision requirements.
3. Licensing approval in the US comes from the Office of the Controller of the Currency and state banking regulators; in the EU, it is granted by national regulators backed by the European Central Bank.

How is the market reacting to stablecoins?

A few stablecoins are already in use today, including Tether (USDT), Circle’s USD Coin (USDC), and Binance USD (BUSD), all pegged to the US dollar. The state of Wyoming recently became the first to launch a state-owned stablecoin. E-commerce giants like Amazon and Walmart are also exploring the use of stablecoins to bypass the traditional financial system of banks and card networks.

In tandem with regulatory clarity and increased adoption, there has naturally been increased interest among traditional banks, especially in the US, to offer their own stablecoins. Many have already launched stablecoins or are preparing to launch a stablecoin offering.

Large US lenders, including Bank of America and Citibank, are already known to be working on launching stablecoins. Even J.P. Morgan Chase CEO, Jamie Dimon, who often expressed skepticism about cryptocurrencies, recently revealed that the bank might consider involvement in stablecoins – but without divulging any details.

For banks, launching their own stablecoins is a great way to get capital inflows as an alternative to traditional customer deposits. Any capital received via issuance of stablecoins can be used to earn interest via “risk-free” investments (for example, T-Bills), providing an attractive additional revenue channel.

Stablecoins also provide a strategic opportunity for the banking sector to gain a slice of the future payments landscape. The $35 billion acquisition of Discover Financial Services, which closed this year, highlighted the importance of the market share within the space with many institutions pursuing the acquisition which finally was closed by Capital One. That said, stablecoin use for payment is still minimal, and it only competes with the card networks’ debit businesses, which only represent about circa 10–15% of Visa’s profits and 5–10% of Mastercard’s, with the lion’s share dominated by credit.

Conclusion

The leap in regulatory clarity is opening the gates for new financial institution entrants into stablecoin markets, both in the US and the EU. This week’s announcement of collaboration between the US and the UK in the space only helps reinforce the probabilities for upside on this market. The market is still small, but stablecoins hold the potential to make a significant impact on global financial infrastructure by offering a new means for end users to transact digitally and helping reshape market structure among banks and payment institutions.