If even my 75-year-old grandfather is tracking the price of bitcoin, cryptocurrency has surely hit the mainstream. Not only that, but the more niche applications of blockchain are gaining popularity. We are starting to see stablecoins mentioned as potential solutions to economic crises, and I’m pretty sure I heard “DeFi” referenced casually on a global news broadcast.
So, what’s happening and what does it mean for the future of finance?
From speculation to stability
A quick recap: As interest in cryptocurrencies skyrockets, price fluctuations increase. If the end goal is to establish real-life use cases, this volatility needs neutralising. Enter stablecoins.
Stablecoins peg their market value to an external asset. They can be collateralised with fiat, crypto, a combination of both, or commodities such as gold. There are also algorithmic stablecoins, wherein an algorithm calculates the supply required to keep value fixed without the need for collateral, but for the purposes of this article, we’ll limit our scope to the stablecoins tackling economic challenges and democratising financial access by powering decentralised finance (DeFi).
Confronting economic challenges
Much like their ability to neutralise crypto volatility, stablecoins offer an alternative to fiat price fluctuations in countries facing uncertain economic and political conditions. In Brazil, stablecoins have found multiple use cases to circumvent oscillating margins. In Venezuela, they’re a solution to hyperinflation. In Hong Kong, citizens turn to stablecoins as a means of keeping financial assets independent of government control.
Though the adoption of innovative financial technologies like stablecoins is driven by instability, the infrastructure – not to mention trust in digital alternatives to legacy financial systems – will remain long after stability is restored. This is especially true once the limitations and associated costs of conventional financial infrastructure when compared to blockchain-powered payments become evident to consumers.
Democratising financial access
Stablecoins have yet to enter common vernacular – only 25.4% of respondents to the Future of Money survey had heard of the term – but they are permeating the financial markets of emerging economies. Already valued at more than $10 billion, stablecoin projects are instrumental in helping unbanked farmers access affordable financing, facilitating lower remittance costs, and much more.
Faster transactions at lower costs is certainly appealing, but the fundamental advantage of stablecoins is the low barrier to entry. Anyone with an internet connection can, at the very least, send and receive money. More advanced users can begin exploring additional capabilities.
Powering decentralised finance
As the majority of DeFi protocols use the Ethereum blockchain, increased interest in DeFi correlates to the rapid growth of stablecoins on the Ethereum network. Stablecoins underpin DeFi operations, such as lending and borrowing, that replicate traditional banking systems. The difference? Because DeFi is committed to transparency, it removes barriers to financial participation by circumventing many of the prerequisites of traditional finance – no need for a bank account, credit card, or complex KYC procedures.
DeFi protocols, such as Aave, run on smart contracts – programmes stored on a blockchain that execute commands when predefined conditions are met. For example, say you want to earn interest on your stablecoins, whether that be USDC or DAI. Storing your funds in a smart contract enables you to earn a passive income – the interest rate is decided by market supply and demand. Using a smart contract removes the need for an intermediary, which in turn cuts costs and allows users to directly access financial services – as long as they agree to the specific set of rules outlined in the smart contract they commit to, of course.
So what’s the catch?
Complexities to (over)come
The biggest barrier to widespread adoption of DeFi is its inherent complexity. The decentralised, permissionless nature of DeFi protocols is simultaneously one of the main attractions and the biggest risk. If traditional banks act as guarantors in case anything goes wrong, the same cannot be said for the decentralised autonomous organisations (DAO) facilitating smart contracts, which are susceptible to corruption by faulty code – intentionally or not.
Then there’s the cost of gas. Anything on the Ethereum blockchain is subject to a gas fee – determined by the computational effort required to execute operations. In a financial ecosystem making its name in having low barriers for entry, gas prices are inhibitive. Until the proposed solution is implemented, microtransactions are out of the question – essentially preventing participation by those who stand to gain the most from an alternative to traditional finance.
And, finally, we can’t forget regulation. As financial technology advances, regulators are hot on its heels. In the tightly regulated UK market, for example, cryptocurrencies have been deemed to remain “outside the perimeter requiring authorisation”, while stablecoins will be moved “firmly inside the regulatory perimeter”, because the government “views their broad use for payment as a financial stability risk”.
In other jurisdictions, similar concerns have arisen. It’s impossible to talk about stablecoins without mentioning Diem – or Libra, as it was then known. Albeit a centralised rather than decentralised stablecoin, it brought many regulatory concerns to the fore. Worried about the virtual currency’s “challenge [to] the supremacy of the US dollar”, governments, financial institutions, and regulators sought to retake control of the narrative.
DeFi presents an even more complex regulatory conundrum. After all, as the SEC Commissioner, Hester Pierce, explains, “…most of the way we regulate is through intermediaries – and when you really build something that’s decentralised, there’s no intermediary.”
Conclusion
Having acknowledged the challenges to mainstream adoption, let’s go back to the original question – where are we headed? The answer is simple: this is still the early stages of a radical new technology. If traditional financial infrastructure is centuries old, blockchain was only conceptualised 30 years ago. Its first practical application is just over a decade old.
From a holistic standpoint, stablecoins and DeFi promise a more equitable global financial system. The transparency and accessibility of the technology imagines a world where the 2 billion unbanked can build financial stability, gender inequality is reduced, global wealth is redistributed, and the global economy is changed forever.