Today, there are over 17,000 cryptocurrencies that are tracked by the website cryptomarketcap.com with a total market capitalization of almost 2 trillion USD. Despite this enormous growth, the prices of cryptocurrencies are still very volatile. This volatility led to the emergence of a special category of cryptocurrencies called stablecoins.
In 2014 the first stablecoin has been issued. As the name suggests, stablecoins are digital assets with the aim to maintain a stable value by either being collateralized with a fiat currency or other assets (commodities, crypto assets, etc.). There are also other types of stablecoins such as the algorithmic based ones where the stability of the price is driven by controlling the supply of the coins via an algorithm.
Stablecoins are primarily used as a store of value by traders for executions of trades to avoid unnecessary fees and to be able to trade 24/7 without any transaction delays. Over the years stablecoins gained more attention from public and regulators due to the increase in market capitalization, which could eventually create systemic risk and therefore have an impact on financial stability.
One of the risks stablecoins face is that they are not sufficiently collateralized. This is still a trigger to discussions in public and with regulators about the necessity of regulations. But how will stablecoins develop in 2022 and what are five things to keep an eye on?
1) Market Capitalization
The market capitalization of stablecoins significantly increased during the last years. The chart below shows the development of the market-cap of four major stablecoins (green line: Tether, orange line: USDC, blue line: BinanceUSD, black line: Dai) over the years and records a significant increase of market cap for all of them. For example, market cap of Tether increased from beginning of 2017 to beginning 2022 by over 3.000 %.
Stablecoins currently make around 9% (at publication of this article) of the total crypto market capitalization. We note that there has been a high and increasing demand for stablecoins. Is it likely to keep the pace in 2022? There are several factors, which could have an impact on the demand of stablecoins and therefore on the pace of the growth of the market cap:
Potential upcoming regulations of stablecoins could have a positive impact on the demand of stablecoins and the trading volume, meaning for example regulating collateralization and therefore improving the trustworthiness. This further could lead to lesser fiat but more stablecoin transactions. Also the issuance of new stablecoins could be more difficult due to stricter requirements.
Interest rate policy in US
It’s important to know that the majority of stablecoins are USD-pegged at the moment. In the Euro-area EUR-pegged stablecoins aren’t common due to the current very low or even negative interest rates.
As a response to higher than usual inflation, it is widely expected that interest rates in the US will be raised in 2022. What would that mean for stablecoins? Stablecoins are dependent on the stability of a value of a fiat currency. On the one hand, higher interest rate would strengthen the dollar and could further stimulate the demand of USD-pegged stablecoins. On the other hand, there could also be an indirect effect when the demand for some stabelcoin use cases (like staking or lending) could be shifted to traditional finance due to better conditions. Why should you take additional risk of stablecoins if you can earn the same interest rate from USD?
General development of crypto markets
In the past decade, cryptomarkets went through several boom and bust cycles. During the bull market, prices of many cryptocurrencies increased tremendously, which was followed by a severe crash and years long of bear market (crypo winter) when the prices stagnated in low levels compared to the latest all time highs. Although the total market-cap of stabecoins was not affected negatively in the previous bear markets, it’s not certain how the next bear market would impact the demand on stablecoins. Until a few years ago, stablecoins were in their infancy but today they already reached a relatively significant market cap. What a long bear market (if it happens) means for stablecoins is still to be seen. Therefore, how the public and institutional interest on cryptocurrencies in general will grow in 2022 and upcoming years, will be key on the further development of stablecoins.
2) Development of Regulatory Framework
The market capitalization of stablecoins is growing quickly enough to gain the attention of the regulators. This is not surprising because they create a link between the crypto market and the traditional global financial system.
On a global level the Financial Stability Board, which is the international body that monitors and makes recommendations about the global financial system, published a report with high level recommendations to regulators, about how to regulate stablecoins (October 2021).
In Europe the European Commission has already taken first steps by proposing a regulation on markets in crypto-assets (MiCa) in September 2020 (expected to come into force in 2023 or 2024), which is part of the digital finance package with the aims to provide legal certainty, consumer and investor protection, support innovation and ensure financial stability. The focus of MiCa lies on asset-referenced tokens and electronic money tokens, which cover stablecoins.
Outside the EU the development of regulations is going in different directions: While China’s government banned all crypto transactions and mining — which also impacted stablecoins in 2021 — the discussions in the US about regulating stablecoins are still ongoing. Currently there is no equivalent to MiCa in the US. In December 2020 US government has presented the Stable Act, a bill to regulate stablecoins but disappeared again due to a change in executive power. However, the President’s working group on financial markets released the “Report on Stablecoins” (November 2021) which indicates the urgency of having a consistent and comprehensive regulation. It is still unclear who will take responsibility to establish the rules but some administrative officials expect the Congress to act. In my view these are some indications that US will release regulations around stablecoins soon and likely in 2022. I believe that regulation will have a positive impact as it removes uncertainty.
3) Stablecoins in countries with high inflation
In countries with high inflation where the local currency loses its purchasing power rapidly, the citizens look for ways to store their wealth. Traditionally many buy and hold hard currencies (USD, EUR, etc,) in bank deposits as well as real assets like houses.
Recently Turkish citizens also turned to stablecoins as an alternative store of value in response to high inflation and rapidly depreciating local currency. For example Turkish Lira has just become mostly traded fiat currency pair to buy Tether as the Turkish Lira lost its value against USD significantly.
Similarly in Brazil the devaluation of Brazilian Real led to a significant demand for stablecoins, like USDT and Dai. In Brazil it is not allowed to store foreign currency in a local bank account and further financial operations are subject to taxes. Such restrictions are probably increasing the demands for alternatives like stablecoins. But this might change soon, as the new foreign exchange law (14.286/2021) considers the possibility to hold bank accounts in foreign currencies.
In summary, high inflation and devaluation of local currency come with challenges for the monetary authorities as it can accelerate dollarization process in such countries. Stablecoins are also outside of the traditional financial systems adding additional difficulties to monitor capital overflows. Therefore, it is expected that regulators in these countries will try to ban or strictly regulate stablecoins. I think it will be interesting for the rest of the world to see the consequences of such regulatory initiatives.
4) Impact on payment industry
Cross-border payments traditionally involve separate national payment systems where different regulatory requirements apply and are linked to high transaction fees, currency conversion costs, inefficient execution, financial exclusion and time delays. Stablecoins as new means of payment have the potential to overcome the disadvantages of traditional payment methods and significantly change the future of payments. While payment service providers like Mastercard have already enabled end-users the connection of crypto wallets to their network for transmission and allows retail settlements in crypto payments, PayPal recently announced that it is working on its own stablecoin.
In the past, when Facebook together with several other companies announced the Libra (Facebook’s original stablecoin project with other partner companies), the regulators demonstrated strict objections due to its implications on monetary policy, financial stability, money laundering, privacy etc. This led to many participant companies of Libra project to withdraw and even after a re-branding (Diem) the project has been effectively shut down.
It seems that PayPal is open to work with regulators, although details about where and when its own coin will be issued are not published yet. Compared to Facebook, PayPal is already well-established in the financial industry, and it already entered the crypto market by allowing payments in selected cryptocurrencies. In my view the chance for PayPal to launch its own stablecoin before other companies is high. It will still take some time due to different factors (testing phases, regulations, etc.) but it’s worth to follow the development in this revolutionary industry.
5) Impact of CBDCs on stablecoins
Central Banks around the world are currently researching, developing, testing and preparing to launch a Central Bank Digital Currencies (CBDCs). The first central banks launched already their CBDC, like the Central Bank of Nigeria (the e-Naira) and the Central Bank of Bahamas (the Sand Dollar) and in 2022 it is likely that further central banks will launch their first pilots. However, a CBDC of a major central bank is still to be developed. In the US the Federal Reserve Board recently released a discussion paper (January 2022) that examines the pros and cons of a potential USD CBDC and is open for public comment for 120 days. The Fed didn’t take any position on the actual issuance of a CBDC. In my view this could be an indication that it will still take some time until an actual launch. Nevertheless, it is still worth to keep an eye on the feedback to the discussion paper and the developments in 2022.
In the Euro area, the European Central Bank is still researching on a digital euro as a CBDC. However, it could take several years until its possible launch.
In my view the launch of CBDCs could have an impact on the future of stablecoins because both could potentially be used for a similar purpose. However this will strongly depend on the development of regulations, in particular in the US as most stablecoins are USD-pegged. Therefore, it is still worth to keep an eye on the feedback to the discussion paper and the developments in the regulatory developments in 2022.
The evolution of stablecoins will have a significant contribution to the future of finance. Total market capitalization of stablecoins and development of the regulatory frameworks around the world would be the most significant things to watch out for in 2022. It will be especially important to see how the regulators and policymakers will react to the increasing use of stablecoins like USDT in countries with high inflation as they can pose systemic risks in such countries. On the business side, use of stablecoins in the payment industry could accelerate as more companies like PayPal plan to adopt the technology. Last but not least, CBDC could have a huge impact on stablecoins, if introduced by major central banks like FED and ECB. Probably this will take several years but it is definitely worth to keep an eye on their plans.
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