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A few years ago, if you had heard that the US government could have minted their own digital currency, you could have dismissed the idea as a starry futurism or, less charitably, a joke. Digital currencies, like Bitcoin, were the purview of speculators and programmers, not boring central bankers. But this winter, the Federal Reserve announced that it is considering issuing its own digital currency. Speaking at Stanford, Federal Reserve Governor Lael Brainard noted that the “potential of digitization to offer greater value and affordability at a lower cost” has piqued the interest of the traditionally risk-averse institution.
For now, the Fed’s interest in the digital currency may be more notable as a sign of how the world has changed and where the winds are blowing. Because just like Paypal and eBay (or Alipay and Taobao, if you prefer) have revolutionized the way people shop online and Amazon has changed the way people shop, all-round digital payment services – powered by technology blockchain – could be the next big upheaval in the e-growth of commerce. For this to happen, however, four conditions need to be aligned: appropriate technology, consumer demand, corporate advocates, and a susceptible regulatory environment.
The question is how. Despite all the hype surrounding blockchain – the open source digital ledgers that many have claimed will do everything from making money obsolete to remaking the global economy – it can sometimes seem like a solution in search of a problem. While it has found its place in niches such as supply chains and digital IDs, issues like price volatility and the need to comply with the existing regulatory framework have prevented mainstream currency adoption. But now, a promising cryptocurrency category known as “stablecoin” looks poised to succeed where its predecessors failed. Uniquely positioned to act as a medium of exchange in ecommerce, stablecoins improve the efficiency and reach of ecommerce.
Finding the right application for Blockchain
As the name suggests, stablecoins stand out from their more popular but highly volatile cryptocurrency brethren, such as Bitcoin, in their focus on price stability. In fighting for stability from the start, stablecoins hope to avoid situations like the one Laszlo Hanyecz experienced in 2010. Hanyecz was a US-based software programmer who agreed to pay someone 10,000 Bitcoins for two Domino pizzas. (a fair price at a time when Bitcoin was only worth a fraction of a cent). Today, this transaction would be worth nearly $ 100 million. Hanyecz was proving a point – this was the first example of an asset bought with a cryptocurrency – but the now legendary story has also become an allegory of the pitfalls of using a notoriously volatile offering for daily purchases.
Stablecoins have taken a variety of approaches to address this price volatility problem. The highest-profile attempt so far – and the most controversial – was Facebook’s new, yet to be released cryptocurrency project, Libra, which was supposed to be tied to a basket of short-term government bonds and historically stable bank deposits. currencies such as US dollars and euros. The pushback by traditional regulators and financial institutions has caused Facebook to move away from its original vision of a global currency competing with monetary authorities. While there is still a lot of uncertainty about the project, it may look more like Venmo, with people sending dollars via Facebook.
Terra (where Nicholas works) is a new stablecoin that has been adopted by several online merchants across Southeast Asia. It is less well known in the US, but it is an example of how stablecoins actually work in nature – a blockchain currency with a reliable value that ordinary people actually use. Unlike Libra, it uses a form of automated monetary policy to keep its price stable by contracting the supply when prices are too low and expanding it when prices are too high. This is achieved by using a second cryptocurrency, Luna, which serves as a monetary policy tool and earns transaction fees as a form of reward. And while the criticisms of Libra have mainly centered on how its governance mechanism is controlled by some large corporations – the Swiss-based Libra Association – Earth’s policy is encoded directly on its blockchain and therefore is transparent and impervious to human interference.
Terra’s stability and transparency are important because they harness the potential of the blockchain in a form that is useful for ordinary people. This, in turn, prepares him to challenge existing technologies. In the case of Terra, this means accepting credit cards.
Better than a credit card
Enthusiasts often point out the potential of cryptocurrencies to improve both the efficiency and reach of e-commerce. The existing financial system, while certainly functioning, has its share of inefficiencies, including reliance on intermediaries, which often come in the form of credit card providers who charge up to 3% per transaction. Blockchain technology allows payments to be made directly between buyers and sellers, bypassing the existing system and reducing costs for both merchants and consumers. Blockchain also allows for the automation of the transaction verification process, in which most banks today still spend significant resources on expensive manual verification. In fact, Santander InnoVentures estimated that “blockchain technologies could reduce banks’ infrastructure costs by $ 15-20 billion per year by 2022”. These benefits will lead to faster settlement times and cheaper international transactions.
As demonstrated by Square’s staggering success in attracting small businesses with lower fees, the increased efficiency of stablecoins is likely to translate into a broader reach. Merchants, who incorporate these fees into their prices, may be more willing to offer their products online due to the lower rates. Likewise, customers may decide to hold balances in digital currencies and complete multiple transactions online without ever switching back to fiat currency or feeling the need for a credit card account. For the 25% of U.S. households that the FDIC has identified as bank-free or underbanked, the lower fees and lack of barriers to entry could be transformative. Finally, the general distrust of financial intermediaries leading millennials to flee traditional banks for fintech and challenger banks suggests they would be willing to embrace cryptocurrencies.
These characteristics could prove to be the advantage that drives stablecoins into the financial mainstream. To understand the effects they could have on the ecommerce ecosystem, we can use data from Terra, which has experienced explosive growth since launch in June 2019, growing 35% month-over-month. It now has over 1 million users, who frequently use it for online purchases ranging from grocery shopping to hotel reservations. Thanks to the ease of onboarding and lower rates, merchants were the first to promote Terra over alternative payment options, such as credit cards, thus facilitating its rapid adoption. Terra’s growth was driven by a significant reduction in the adoption of other payment systems, including credit cards. This suggests what e-commerce 2.0 might look like in the Western world as well.
If stablecoins are about to go mainstream, however, they need innovative corporate champions and outsiders and are starting to win over influential insiders. Facebook’s debacle in the launch of Libra was instrumental in drawing attention to this opportunity and accelerated similar developments elsewhere. Financial institutions, including JP Morgan, have recognized the need for a digital currency for payments. Jack Dorsey’s Square recently won a patent for a network that allows consumers to pay with cryptocurrency and merchants to receive the full value in US dollars, eliminating any concerns about cryptocurrency volatility. Finally, the entire financial ecosystem is evolving – challenging banks like Revolut accepting cryptocurrencies, for example – which makes future developments and integration more likely.
But will people use it?
There are still major hurdles to overcome for blockchain currencies, regardless of existing incentives. For most of the world, the use of cryptocurrency to pay for goods and services is limited to certain niches. There are some major retailers, including Starbucks and Overstock.com, that accept encryption, but they are outliers. A blockchain research firm, Chainalysis, found that only 1.3% of cryptocurrency transactions worldwide were associated with commercial transactions in the first four months of 2019, suggesting that speculation remains the primary use of bitcoin.
The regulation could change that. Banks have been reluctant to get involved in cryptocurrency projects due to the potential scrutiny by skeptical regulators, which in turn has made most companies suspicious of the technology and slowed its adoption. Policy makers are concerned about shifting control of monetary policy from sovereign countries to commercial enterprises. The ability of central banks to expand and contract the money supply is an important part of their policy toolkit, enabling them to stabilize growth and inflation in times of need. Data privacy is also a major concern. This is a particularly poignant issue after Facebook’s well-documented data security and privacy controversies; it will be a key focus of any future stablecoin.
Right now, three of the four pieces needed for an e-commerce transformation at the hands of stablecoins are in place: the right technology, consumer demand, and business champions. If a susceptible regulatory environment materializes in the coming years, the adoption of stablecoins as a means of payment could increase the adoption of blockchain technologies beyond current niche uses and has the potential to breach barriers to entry into e -commerce market.
If major financial institutions such as the Fed gave their stamp of approval, we might indeed see less reliance on fiat and paper money in our daily lives. If more and more of our purchases are made online and cashless shops become more popular, why the need to switch digital currency into paper money? Big retailers like Amazon could launch their own digital coins. Soon, we may not wonder if cryptography will ever catch on, but if we’ll miss seeing George Washington’s face.
