Stablecoins reveal the inefficiencies of traditional finance! But they may not bring financial democracy, rather a re-concentration of power.

Stablecoins improve payment efficiency but deviate from the original intention of decentralization. Under regulatory shifts and the entry of giants, they may exacerbate financial power concentration and reshape the global monetary order.

Early pioneers of cryptocurrency aimed to break the monopoly of central banks and large commercial lending institutions over financial intermediaries. The grand goal of initial crypto assets like Bitcoin and the underlying blockchain technology was to bypass middlemen and connect trading parties directly.

This technology aims to achieve financial democratization, allowing everyone, regardless of wealth, easy access to a wide range of banking and financial services. Emerging financial institutions will leverage this technology to offer competitive financial services—including customized savings, loans, and risk management products—without the need to establish expensive physical outlets.

All of this is intended to clear out old financial institutions that lost public trust during the global financial crisis and to establish a new financial order. In this decentralized financial new world, competition and innovation will flourish. Consumers and businesses will benefit from it.

But this revolution was quickly overturned. Decentralized crypto assets like Bitcoin are inherently created and managed by computer algorithms, and it has proven that they are infeasible as a medium of exchange. They experience extreme value volatility and cannot process large volumes of transactions at low cost, making them unsuitable for daily use and preventing them from achieving their original goals. Instead, Bitcoin and other crypto assets ultimately became what they were never meant to be—speculative financial assets.

The emergence of stablecoins filled this gap, becoming more reliable mediums of exchange. They use the same blockchain technology as Bitcoin but maintain stable value by being pegged one-to-one with central bank reserves or government bonds.

Stablecoins promote the development of decentralized finance, but they themselves run counter to decentralization.

They do not rely on decentralized trust mediated by computer code but depend on trust in the issuing institutions. Their governance is not decentralized; users do not decide rules through open consensus. Instead, the stablecoin issuing institutions determine who can use them and how. Stablecoin transactions, like Bitcoin, are recorded on digital ledgers maintained by decentralized networks of computer nodes. But unlike Bitcoin, these transactions are verified by the stablecoin issuers, not by algorithms.

Payment Channels

Perhaps a broader goal is more important. Stablecoins can still serve as channels for people across income levels to access digital payments and DeFi, weakening the long-standing privileges of traditional commercial banks and, in some ways, narrowing the gap between wealthy and poor countries. Even small countries can benefit by more easily integrating into the global financial system, reducing friction with payment systems.

Stablecoins indeed lower payment costs and reduce payment friction, especially in cross-border transactions. Economic migrants can remit money to their hometowns more conveniently and economically than before. Importers and exporters can complete foreign transactions instantly without waiting days.

However, beyond payments, DeFi has become a stage for financial engineering, spawning many complex products whose value beyond speculation is questionable. DeFi activities have hardly improved the lives of impoverished families and may even harm retail investors—those lured by high returns but lacking experience and ignoring risks.

Regulatory Shift

Will the recent US legislation allowing various companies to issue their own stablecoins promote competition and curb some less reputable issuers? In 2019, Meta attempted to issue its own stablecoin Libra (later renamed Diem). But due to strong opposition from financial regulators, the project was ultimately halted. Regulators worry that such stablecoins could weaken the effectiveness of central bank currencies.

With the regulatory environment in Washington shifting and a new government more friendly toward cryptocurrencies, the door has opened for private stablecoin issuers. Stablecoins issued by large US companies like Amazon and Meta, backed by their substantial balance sheets, could dominate other issuers. Issuing stablecoins will strengthen these companies, leading to increased market concentration rather than more competition.

Large commercial banks are also adopting new technologies to improve operational efficiency and expand their scope. For example, converting bank deposits into digital tokens that can be traded on blockchain. It is foreseeable that someday, large banks may issue their own stablecoins. All these developments will weaken the advantages of small banks (such as regional and community lenders) and consolidate the power of large banks.

International Dominance

Stablecoins may also reinforce the existing international monetary system. The stablecoins backed by the US dollar are the most in demand and the most widely used globally. They may indirectly enhance the dollar’s dominance in the global payment system and weaken potential competitors. For example, Circle, which issues the second most popular stablecoin USDC, has low demand for its other stablecoins pegged to major currencies like the euro and yen.

Even major central banks are uneasy. There are concerns that dollar-backed stablecoins could be used for cross-border payments, prompting the European Central Bank to issue a digital euro. The payment systems within the Eurozone remain fragmented. While transfers from Greek bank accounts to German bank accounts are possible, paying with funds from other Eurozone countries’ bank accounts in another Eurozone country is still not very convenient.

Stablecoins pose a survival threat to small economies’ currencies. In some developing countries, people may trust stablecoins issued by well-known companies like Amazon and Meta more than their own high-inflation, volatile local currencies. Even in economies with reliable central banks and sound management, people may find it hard to resist the temptation of stablecoins, as they are convenient for both domestic and international payments and are pegged to major global currencies.

Inefficiencies of Traditional Payment Systems

Why have stablecoins gained such rapid attention? One reason is that high costs, slow processing speeds, complex procedures, and other inefficiencies still plague many countries’ domestic and international payment systems. Some countries are considering issuing their own stablecoins to prevent their currencies from being marginalized by dollar-backed stablecoins. But this approach is unlikely to succeed. They are better off first fixing their domestic payment systems and collaborating with other countries to eliminate frictions in international payments.

Stablecoins seem safe but hide many risks. First, they may facilitate illegal financial activities, making money laundering and terrorist financing harder to combat. Second, they could establish private, independently managed payment systems, threatening the integrity of the overall payment infrastructure.

Solutions

The solution seems obvious: effective regulation can reduce risks, leave room for financial innovation, and ensure fair competition by curbing the excessive concentration of economic power in a few companies. The internet has no borders, so regulating stablecoins at the national level is less effective than international cooperation.

Unfortunately, in the current environment of limited international cooperation and countries actively defending and advancing their own interests, such outcomes are unlikely. Even major economies like the US and the Eurozone act independently on cryptocurrency regulation. Even with more coordinated efforts, smaller economies will find it difficult to participate in decision-making. These countries often have weak financial systems, limited regulatory capacity, and high hopes for sound regulation, yet they may be forced to accept rules imposed by major powers that almost ignore their own interests.

The role of stablecoins is to reveal the inefficiencies in the current financial system and demonstrate how innovative technology can address these issues. However, stablecoins may also lead to greater concentration of power. This could give rise to a new financial order—not as envisioned by crypto pioneers as a system full of innovation, competition, and fair distribution of financial power, but one that brings greater instability.

• This article is reprinted with permission from: 《Foresight News》
• Original title: 《The Stablecoin Paradox》
• Original author: Eswar S. Prasad
• Translation: Eric, Foresight News