Following the recent collapses of Silvergate Bank and Silicon Valley Bank which both had significant exposure and investments in decentralised finance (DeFi), there has been increasing doubts around the credibility and reliability of the use of digital assets for mainstream purposes. The news sent shock waves across the entire financial services sector, with both collapses reestablishing concerns around not only digital assets and cryptocurrencies, but the state of the banking sector as a whole.

Despite this recent market turbulence, it is important that the long-term potential for DeFi technologies isn’t overlooked and underappreciated. In fact, in a recent speech about crypto, US Federal Reserve’s vice-chair Michael Barr, stated “We have not lost sight of the potential transformative effect that these technologies could have on our financial system… But the benefits of innovation can only be realised if appropriate guardrails are in place.”

For emerging markets in particular, digital assets have a crucial role to play. Stablecoins, in particular, are already having a transformative effect on cross-border transactions, and a key role in driving financial inclusion. Let’s explore why.

The potential of stablecoins

Financial institutions, fintechs, international development organisations, and corporate entities need to move money to and from hard-to-reach markets. Conversely, these markets need access to the wider global financial system to improve liquidity, boost trade and facilitate foreign aid.

Today these organisations rely on correspondent banking.

With growing demand to move money in and out of emerging markets you’d expect the correspondent banking network to be growing, but in reality, it is shrinking. The latest figures show that correspondent banking relationships contracted by 25% from 2011 to 2020 (BIS, 2020).

Not only is the correspondent banking network contracting, payments via the network are generally slower, more expensive and more opaque than other payment methods.

The challenges facing correspondent banking, and cross border transactions more widely, can be overcome by stablecoins. These include:

  • Removal of the ‘middleman’ – Fiat currencies have a centralised approach, which uses a public key infrastructure (PKI), which is used to secure the entire chain, dependent on a central authority (CA). Blockchain removes the need for CAs, thus removing the middleman, and improving efficiency, security and cost.
  • Efficiency of transactions – Stablecoins are maintained by blockchain technology and avoid the requirement for multiple counterparties to settle transactions. This means transactions are conducted in a fraction of the time.
  • Reduced cost of transactions – Efficiency goes hand in hand with reduced cost. By removing counterparties, all of whom take a small fee for handling the transaction, stablecoins dramatically cut the cost of moving money across borders.
  • Minimised volatility – Unlike other digital currencies, stablecoins are pegged to a fiat currency or commodity, which results in little to no volatility making them ideal for delivering cross border transactions.
  • Increased liquidity – Stablecoins boost liquidity for fiat currencies they are pegged to, which other digital assets do not, allowing users to manage their risk around drops in the price of cryptocurrency.

Is the future of cross-border payments in stablecoins?

Cross-border transactions are vital for enabling global trade, and supporting the increasing globalisation of businesses. They are also crucial for remittances, to allow migrants to send money to their origin countries, or allowing migrants to receive funds from their origin countries. In 2022, remittances to low- and middle-income countries withstood global headwinds, growing an estimated 5% from 2021 to $626bn (World Bank, 2022). However, despite their importance, cross-border transactions can be slower, more expensive and more opaque in comparison to domestic payments.

For example, in the second quarter of 2022 the average costs of sending $200 to low- and middle-income countries remained high at six per cent, well above the target of three per cent of the UN Sustainable Development Goal.

In many ways, the high cost of remittances is a “tax” on the poorest people in the world.

Stablecoins could be the answer to these challenges. They have the potential to improve speed and transparency, offer more utility, and critically reduce high costs, in comparison to existing methods such as correspondent banking or real-time payment rails, which often rely on traditional banking infrastructure.

Critically, stablecoins are a boon for receivers in emerging economies. In many markets, individuals cannot receive payments from family and friends abroad in major G10 currencies, particularly USD, let alone organisations looking to do business with these areas. Stablecoins allow these G10 currencies to be remitted to an individual or business with a domestic currency account so they can receive foreign currency payments.

Stablecoins and financial inclusion

According to a recent Findex report, across the globe, 1.7 billion adults are currently unbanked by traditional banking services. Stablecoins could be the answer to providing more people with access to financial services, and promoting overall financial inclusion and wellbeing. Here’s how:

  • Facilitate local movement of money – stablecoins can be used to make everyday transactions in the local area, using a USD wallet, which supports movement of money in the local economy as well as small businesses within a region.
  • Allow G10 remittances – remittances are often facilitated by traditional payment rails, which can be slow and cumbersome. Using digital ledger technology, stablecoins can allow the movement of G10 remittances into a country more easily, which can boost emerging market economies that are often reliant on these in-demand currencies.
  • Unlocking other financial services – by using stablecoins for everyday transactions, the possibility of additional financial services can be unlocked, such as loans and insurance, which are often unattainable without a financial history.

A unique opportunity

Despite recent market uncertainties, and a so-called ‘Crypto winter’, all is not lost when it comes to digital assets, particularly stablecoins. Their lack of volatility and reliance on traditional payment rails make them the ideal solution for boosting emerging market economies and improving financial inclusion and wellbeing.

We must be careful not to throw out the baby with the bathwater.

James Cope is Head of Product Management and Michael Goldfarb, Chief of Staff & President, US, at Crown Agents Bank