Stablecoins: Banking as a Service Yet to be Fully Explored

cdLast Updated: July 4, 2024

3 minutes read

Stablecoins are essentially a form of internet-native monetary liability, representing a new generation of Banking as a Service (BaaS).

The form (assets) of stablecoins will not change, and we are just beginning to explore their utility. Here are some thought models predicting the future development of stablecoins:

Stablecoins as the New Generation of BaaS

In Web2 fintech, a wave of startups provided Banking as a Service (BaaS) to build new applications on top.

These BaaS companies acted as middleware, simplifying the complexity of interacting with traditional banks. Companies like @Venmo, @Wise, @CashApp, and @Affirm benefited from BaaS, introducing new product types such as P2P payments, BNPL, and cross-border payments.

All account holders deposit their funds into fractional reserve banks, assuming the risk that the bank won’t collapse. However, the collapse of Silicon Valley Bank reminded us that nothing is absolutely certain.

Unfortunately, one of the leaders, Synapse, has already gone bankrupt, causing significant distress to its customers and partners.

Another major sponsoring bank, Evolve Bank, experienced a massive data breach due to a Russian hacker attack.

So, what is the alternative to Banking as a Service? If BaaS fueled the growth of Fintech 2.0, then stablecoins are empowering Fintech 3.0.

Fiat-backed stablecoins (e.g., @circle, @Tether_to, @Paxos) represent on-chain claims, with these tokens being collateralized by some form of fiat currency held off-chain somewhere.

Assets

Issuers do not provide loans; they are narrow banks.

Liabilities

Tokens are now distributed on the blockchain. Anyone with a wallet and internet access can purchase and hold these tokens on the secondary market.

Functionally, stablecoins provide consumers with the same services as Banking as a Service (BaaS). Holding $USDC as a non-US user is equivalent to having a dollar account through @Wise. If you hold $USDC, you face the risk of Circle as the issuer, BlackRock as the securities broker, and Circle’s banking partners.

If you have a dollar account through @Wise, you face the risk of Wise’s BaaS partner and its sponsoring bank (fractional reserve).

Why Have Stablecoins Grown So Rapidly in Such a Short Time?

It all comes down to the way liabilities are distributed (deposits in Web2 vs. stablecoins in Web3).

In Web2, deposits are trapped in closed networks (e.g., PayPal and SWIFT). In Web3, stablecoins are recorded on public blockchains from the start, representing open networks.

This also explains why public blockchains might achieve the Lindy Effect, as they become coordination points for all market participants.

The Form of Stablecoins (Assets) Will Not Change in the Future

Because stablecoins must focus on distribution (liabilities), issuers will naturally gravitate towards similar asset compositions.

On Regulation

Regulators (e.g., US, EU, Hong Kong) are narrowly focusing on regulating stablecoins’ assets, specifying asset types and management. If you want to protect consumers, regulating assets makes sense (see Terra/Luna’s algorithmic backing).

While the form of stablecoins won’t change much, their utility (use of liabilities) is far from fully explored.

Imagine, the essence of payment is transferring $x from place A to place B, following certain conditions.

Here’s my thought model:

The payment process consists of three steps:

Payment Entry
Conversion
Payment Exit

In this workflow, you need to consider, for example, what is this payment for? After the transaction is completed, you need to record it in the ledger. Upon receiving the transaction, you need to combine it with the invoice.

Currently, stablecoins have a very obvious utility: deconstructing traditional correspondent banking networks through a new set of service providers. No longer relying on a single SWIFT transaction, you can break it down into: Deposit -> BaaS -> LPs Conversion -> BaaS -> Withdrawal. This way, you can combine the best services at each stage, providing a better user experience.

This is also how @mgiampapa1, @will_beeson, and @bkohli described it on @rebankpodcast.

Is Cross-Border Payment the Only Use for Stablecoins?

I don’t think so.

There is still a lot of untapped potential around programmable money. The “if X, then Y” logic can be applied throughout the payment workflow, enabling value transfer between machines.

How can companies like @sentient_agi monetize the data sources of large language models (LLMs) with each reasoning call?

On Regulation

How do regulators view the utility of stablecoins? To me, the most important thing is to understand your customer (KYC).

The most obvious regulatory conflicts I see are:

If stablecoins do resemble Banking as a Service (BaaS), should regulators oversee them in the same way as BaaS? This is a matter of functional equivalence.
Should stablecoins be allowed to remain anonymous like cash?

If the first scenario happens, the entire stablecoin industry will collapse, with market capitalization and transaction volume halving. This would lead to a significant loss of demand for US Treasuries (UST).