Blockchain in financial services

Stable coins: Enabling payments on blockchain through alternative digital currencies

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How often do you participate in real-life, “live” blockchain transactions? I’m guessing that for many of you, the answer is not often. Though the benefits of blockchain — a distributed ledger technology that facilitates transactions between participants without the need for intermediaries — are well documented, most networks currently in production don’t deal with mainstream buying, selling and trading.

That will soon change as banks, financial institutions, startups, industry leaders and investors begin to ask: How can we make payments on blockchain feasible for everyday use?

Today, I’m excited to discuss the development of a new kind of digital currency that is gaining in popularity — stable coins — which can help increase the viability of performing everyday financial transactions on blockchain.

What is a stable coin?

A stable coin is a digital currency that is pegged to another stable asset like gold, or to major fiat currencies like Euros, Pounds or the US dollar. For the sake of this discussion, I’m using the term “digital currency” to refer to a tokenized representation of fiat currency that is publicly accessible on a public permissioned blockchain network.

Blockchain for financial services

So, what do I mean by a “tokenized representation” of currency? Well, when you go to an arcade or a casino, you exchange your cash for tokens to play the games. In general, the number of tokens or chips you get per dollar is preset and does not change. You could say they are pegged to the dollar. This is key. For any financial instrument (currency) being used to facilitate the exchange of goods or services (payments), stability is crucial to ensuring neither the buyer nor seller lose in trade due to price fluctuations of the underlying payment instrument.

As the name suggests, a stable coin is a digital token that has low price volatility because it is pegged to an underlying fiat currency. Thus, it would work well for practical applications involving payments on a blockchain network as a store of value, a medium of exchange and unit of accounting for routine and everyday transactions of both large and small values.

As applications that make use of blockchain and stable coins become more mainstream, they can help provide merchants, consumers and global suppliers with cheaper, better, faster and more secure alternatives to cash, credit cards, debit cards and wire transfers.

Why not use a regular cryptocurrency?

It’s not that other cryptocurrencies such as Bitcoin, Ether or Lumens can’t be used to facilitate transactions on blockchain. They definitely can and are already being used in production on blockchain networks. Many offer advantages over fiat currencies, for example privacy and anonymity of transactions with real time settlement. However, there are a number of reasons why I think pure cryptocurrencies might not be the best solution for widespread, mainstream use, including:

  • Exchange rate volatility
  • Liquidity issues (which will probably go away over time)
  • Stability, efficiency or control of anonymous networks
  • Scalability of the network (downsides of mining-dependent public networks)
  • Lack of regulatory controls for anti-money laundering or identity management
  • Absence of conventional monetary policy

I’m sure you’ve noticed the price of cryptocurrencies are constantly fluctuating depending on conditions in the market. This is not unlike other currency markets, however with these coins we are seeing 10, 20 or even 30 percent price fluctuations in a single day. I believe this exchange rate volatility, which is present in most cryptocurrencies available today, is one of the biggest barriers to using traditional cryptocurrencies to facilitate everyday transactions on blockchain. Merchants are hesitant to accept cryptocurrencies as payment because their value could suddenly drop or go up the next day. Payment processors are weary because the underlying networks are still maturing and not scalable to the levels of peak processing like transactions on credit card networks — in the case of Bitcoin and Ethereum, not even close!

This volatility and inherent risk means that most financial institutions are wary of using cryptocurrencies as the basis for mainstream commercial transactions and why some countries have banned their use entirely.

What is the future of stable coins?

The “stability” of stable coins could translate into improving the entire backbone of international banking operations, giving banks an innovative way to significantly update their core banking and compliance infrastructure while also helping to improve operational efficiency and regulatory transparency; not to mention, these types of enhancements tend to greatly improve user experience and can help bolster a renewed trust in banks.

At IBM we’ve been exploring new ways to integrate fiat-backed coins as a settlement instrument on our cross-border payments platform. The aim is to give banks an easier way to integrate with public blockchain networks without significant changes to their core banking and compliance infrastructure.

For example, we are experimenting with a new stable coin, Stronghold USD, that is backed by US dollar deposits. We envision startups and financial institutions will provide token issuance and custody services for this new type of financial instrument. Banks could even begin extending credit to real time transactional networks through the issuance of stable coins. This would give them access to new markets and allow them to participate in financing activities like Open Account trade transactions where they currently have little or no participation.

Using our blockchain network, we’ve shown that settlement can be achieved in real time using tokens and coins. There is no post-transaction processing required as with conventional payment systems today. So how does it work? The tokens would be engineered, hosted and managed according to a standards-based lifecycle policy developed by IBM, operating on the Stellar network. Stellar is a publicly accessible, secure and open source blockchain protocol with a number of internal features that set it apart from other distributed ledgers, including a digital asset registry and distributed exchange, making it simple to issue digital tokens and easy to trade and transact with others.

Solution developers, businesses and consumers who wish to hold or exchange the stable coins would be required to comply with terms and conditions set forth by the issuer and its regulatory authorities, including requirements for identity validation and verification, KYC and AML requirements.

We expect the end state will be an improved, real time global payments infrastructure that does not sacrifice regulatory compliance, privacy, security or monetary policy.

Are you ready for payments on blockchain?

There are still challenges to using stable coins, so this new solution will be explored further during a pilot period. The good news is that a successful implementation could be exactly what is needed for payments on blockchain to reach widespread adoption throughout the financial industry.

Welcome to the revolution.

Blockchain for financial services

VP Blockchain and Digital Currencies

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