Leveraging Stablecoins for Cross-Border Payments: A Game Changer in International Finance

The traditional architecture for cross-border payments typically includes the SWIFT network, wire transfer services, and correspondent banking arrangements. These elements entail dealing with numerous intermediaries, inevitably escalating transaction costs and delays. In addition, these systems suffer from a lack of transparency, making the task of tracing transactions and precisely estimating delivery times exceedingly complex.

The Significance of Remittances in Sustainable Development

The United Nations' Sustainable Development Goals (SDGs) address cross-border payments, especially migrant remittances, under SDG 10, which targets reducing inequality within and among countries. Specifically, target 10.c seeks to reduce the transaction costs of migrant remittances to less than 3% by 2030 and to eliminate remittance corridors with costs higher than 5%. Migrant remittances play a crucial role in several SDGs beyond SDG 10, as they provide substantial support to the global economy and poverty reduction. The United Nations acknowledges the importance of making cross-border payments more accessible and affordable for migrants and their families.

However, the reality of the situation presents a stark contrast. As per World Bank data from 2021, the global average cost to send $200 stood at 6.5%. This figure significantly overshoots the UN's target. The situation is complicated further by fluctuating exchange rates and additional fees imposed by financial institutions.

Dissecting the Root Causes

The challenges associated with traditional cross-border payments stem from a range of factors:

1. Complex and Multi-Layered Structure: Traditional cross-border transactions typically involve multiple banks - the sender's bank, the receiver's bank, and often one or more correspondent (or intermediary) banks. Each bank in this chain applies its own fees, driving up costs. This multi-layered structure, coupled with different legal jurisdictions and currency exchange processes, further complicates the process.
2. Extended Transaction Times: The cross-border payments processed through traditional banking systems can take up to several days. This is due to the need for manual checks, Anti-Money Laundering (AML) and Know Your Customer (KYC) protocols, interbank communication and coordination, as well as time zone differences.
3. Lack of Transparency: With multiple banks involved and each having its own processing times, tracking the status of a payment and accurately predicting its delivery time becomes complex. The lack of standardized data formats and the necessity of manual intervention in transaction verification and reconciliation further exacerbate the opacity.

Designers of stablecoins, a distinctive subset of cryptocurrencies, aim to ensure a consistent value that aligns with a specific asset or an array of assets. These stablecoins draw comparisons to various benchmarks, including national fiat currencies such as the U.S. dollar or Euro, as showcased by Tether (USDT) and USD Coin (USDC), or commodities like gold, represented in tokens like Paxos Gold (PAXG), or even a diverse mix of assets.

Unlike traditional cryptocurrencies like Bitcoin or Ether, which are known for their price volatility, stablecoins cleverly merge the inherent stability of traditional fiat currencies with the innovative technology that cryptocurrencies embody. Crypto projects like MakerDAO's DAI, a decentralized stablecoin, exemplify this hybrid nature. Here, a detailed system of collateral and smart contracts ensures the stability of its value. This unique blend offers a compelling proposition in the fast-paced realm of digital currency, potentially serving as a bridge between the traditional financial system and the burgeoning digital economy.

Stablecoins bring a constellation of benefits to the table, conspicuously overshadowing traditional methods of cross-border payments:

• Expediency and Efficacy: Traditional conduits of cross-border payments often entail protracted settlement periods, necessitated by stringent regulatory compliance checks. Stablecoin transactions, contrarily, can be authenticated and executed almost in real-time, a credit to the underlying blockchain technology. This aptitude for swift verification and settlement could dramatically elevate the pace and effectiveness of cross-border transactions.
• Economic Efficiency: The necessity for multiple intermediaries, often contributing to bloated transaction costs in conventional systems, can be tactfully sidestepped by stablecoins. Through the clever application of smart contracts, these transactions can be automated and streamlined, thus diminishing the cost per transaction. This cost reduction proves especially beneficial in the realm of remittances, where elevated transaction fees inflict a disproportionate burden on individuals with lower income.
• Transparency and Fortified Security: Stablecoin transactions are diligently recorded on a transparent, immutable ledger, thereby enabling real-time tracking. This heightened visibility can aid in mitigating fraudulent activities while boosting trust in the system. Additionally, the decentralization inherent in blockchain technology offers stout protection against conventional attack vectors that exploit loopholes in centralized systems.
• Promotion of Financial Inclusion: The promise of financial inclusion is yet another benefit extended by stablecoins. As per World Bank reports, approximately 1.7 billion adults globally are deprived of access to a bank account. For such unbanked individuals, stablecoins may facilitate transactions with merely a smartphone and internet connectivity, thereby potentially broadening the horizon for economic engagement.

Stablecoins, despite offering several advantages like lower volatility reminiscent of Tether (USDT) and faster transactions as seen in USD Coin (USDC), also present considerable regulatory challenges and risks within a complex and evolving regulatory environment. Critical concerns include:

• Legal Status: Depending on their design and governance, stablecoins could fall under different legal categories like money (digital fiat), securities (if linked to profits from a specific project, much like tokens in Initial Coin Offerings), commodities (if connected to physical assets), or derivatives. This directly impacts their interaction with laws and regulations, such as anti-money laundering (AML) measures, consumer protection standards, taxation rules, and securities laws.
• Oversight: The supervision of stablecoin issuers like Circle (issuer of USDC) and intermediaries like crypto exchanges (e.g., Coinbase), wallets, and custodians, could vary greatly depending on their jurisdiction, function, and risk profile. This can potentially result in regulatory gaps, inconsistencies, and even conflicts of interest.
• Financial Stability: If widely adopted, stablecoins could risk financial stability, similar to risks encountered during the 2008 financial crisis. For example, if stablecoins are not adequately backed by reserves, similar to concerns raised with Tether, or if they experience sudden redemption pressures or market shocks like the crypto market crash in 2020, they could pose systemic risks.
• Consumer Protection: Users and investors might face various risks—operational (platform outages), cyber (security breaches), market (price volatility), legal (changes in regulatory environment), and governance (mismanagement by issuing entities).

To navigate these challenges, regulators and policymakers may need to:

• Develop clear, consistent definitions and classifications for stablecoins, which would help achieve legal clarity for issuers like Gemini and users of GUSD, and also ensure a level playing field across jurisdictions and sectors.
• Establish a comprehensive regulatory framework for stablecoin issuers and intermediaries, covering prudential regulation, conduct regulation, AML regulation, data protection regulation, and cross-border cooperation, as has been suggested by entities like the Financial Action Task Force (FATF).
• Enhance monitoring and assessment of stablecoins' impacts on financial and systemic stability, as done by entities like the Federal Reserve and European Central Bank.
• Promote responsible innovation of stablecoins, encouraging adherence to high governance standards, transparency, accountability, compliance, and interoperability, in line with recommendations from the World Economic Forum.

Cross-border payments, despite their current challenges, are a key part of the global economy. The existing methods face issues with high costs, delays, and lack of transparency. The United Nations' goal of making these payments more accessible and affordable, particularly for remittances, is still a work in progress.

Promising advancements, particularly stablecoins, offer potential solutions to these issues. These digital currencies provide benefits like speed, cost-effectiveness, transparency, and financial inclusion. Nevertheless, they bring about new regulatory challenges such as legal status clarification, oversight standardization, financial stability, and consumer protection.

In conclusion, while traditional methods maintain their importance, the future of cross-border payments appears to lie with innovative solutions like stablecoins. If leveraged responsibly, they could revolutionize the system, contributing to a more sustainable and equitable global economy.