Stablecoins Get A New Pal

PayPal’s US dollar stablecoin is a big deal because it further legitimises the sector.

Sep 20, 2023

Dateline: Copenhagen, 20th September 2023.

As I am sure you noticed, there was a rather interesting development in the world of digital money with the news that PayPal is issuing its own digital dollar. While many observers are asking what its purpose is, the financial markets liked the news.. Jose Fernandez da Ponte, PayPal’s senior vice president and general manager of blockchain, crypto, and digital currencies is clear about their advantage: “We have always said that our role in crypto and digital currencies is trying to build that conduit between fiat and web3” and they do indeed have potential as an “on ramp” for retail users.

Stable

The new PayPal USD is issued by Paxos, which is regulated by the New York State Department of Financial Services (NYDFS), and is redeemable one-to-one for US dollars, the company said. That regulation, rather like the European Electronic Money Institution (ELMI) licence, ensures a 100% reserve in “tier 1” assets, which leads to the rather interesting situation that, as J.P. Koning pointed out, there are now two different kinds of PayPal dollars!

On the one hand there are PayPal stablecoin dollars that (because of stringent regulation) are fully backed by the safest sorts of short-term collateral: U.S. Treasury-bills, reverse repo (backed by U.S. government securities) and commercial bank deposits.
On the other hand there are PayPal's regular dollars, which are regulated piecemeal under each U.S. states' own peculiar version of a money transmitter license and can almost always be legally backed by riskier assets. According to PayPal's annual report, only around a third of these dollars are backed by the safe assets noted earlier.

(In my view, the ELMI approach was tested and found safe when Wirecard went under, because Wirecard in the UK was not a bank but an ELMI and, as with the NYDFS stipulation, all customers funds were held in a 100% reserve of commercial bank money. Wirecard shareholders and bondholders were wiped out, as they should have been in a capitalist economy, but customers were not.)

While the purists may be unhappy that PayPal’s stablecoin PYUSD (an ERC-20 token issued on the Ethereum blockchain) retains centralised control (PayPal is able to cancel accounts, block transactions and so on) I think it is important to see the bigger picture here. The purpose of PayPal’s stablecoin (apart from attracting billions in interest-free loans!) is not to be a competitor to a cryptocurrency such as Bitcoin, Dogecoin or whatever else coin. The key role of this new digital currency will be to act as a mass market on-ramp for millions of (initially) Americans who want to access a convenient means of transferring value from what we might loosely label “web 2 money" (online credit cards and bank accounts) to web3, the world of decentralised finance and tokens.

(PayPal may have got the attention, but there is plenty of other very positive activity in the space. For one example, another of the key stablecoin players, Circle, expanded their “Web3” line with the announcement of Programmable Wallets, designed to allow developers to focus on customer-facing functionality.)

with kind permission of Helen Holmes (CC-BY-ND 4.0)

Why do I focus on the onramp to stablecoins? Well, it’s because I agree with Elliot Hentov, head of macro policy research at State Street Global Advisors, who says that the technological revolution in financial services is in the coming tokenisation of wide swaths of financial and real assets. He is absolutely correct to note that these digital assets will will require a “corresponding” (i.e., shared ledger-based) digital currency to make a functioning market in which protocols used to exchange fungible and non-fungible assets (e.g., both the dollars and the ticket for the Taylor Swift concert will be tokens, one fungible and one non-fungible).

Reaction

The reaction to PYUSD has been, it has to be said, muted. A month after launch there is less than $10,000 in daily volume and PayPal’s September “transparency report” shows that there is only some $43m issued. There are only a handful of wallets that have more than a thousand dollars in PYUSD, so the DeFi faithful have yet to transfer away from Tether.

(For comparison, USDT has a market capitalisation of over $83 billion and USDC has a market cap of $26 billion. At the time of writing, USDT stablecoin’s 24-hour trading volume is over $22 billion as compared to PYUSD stablecoin’s 24-hour trading volume of only $3.2 million.)

So will PYUSD get traction? Well, apart from anything else we know that lots of people around the world want to use digital dollars and PayPal has further legitimised the stablecoin approach. And America will benefit from supplying them whether via public or private infrastructure because digital dollars are more than a new electronic payments mechanism, they are a means to reinforce the post-WWII international monetary order and American “soft power”.

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Don’t Cry For Me, Bitcoin

Here is an example to illustrate that point: I saw a tweet from someone who had just sent money to a friend in Argentina using another stablecoin, USDT (Tether). It was the recipient's preferred method of payment. The tweeter pointed out that the recipient had access Bitcoin, but did not want it. What this confirmed to me was that in many places, people want cryptocurrency only as a second-best way of getting fiat currency. They don’t want Dogecoin, they want Dollars. Right now a lot of these dollars are in the form of Tether (USDT) and offshore. But if the dollars are supplied in digital form by a globally-recognised, trusted, audited, regulated and well-run company such as PayPal, I suspect that a great many people will prefer them.

(That example of cross-border payments is often put forward as a key driver for cryptocurrency take up and given the size of the global market, you can see why. Cross-border retail spending and remittances will reach around $5 trillion this year and business-to-business payments are worth eight times that. If even a fraction of those payments are made using PYUSD, then the future looks pretty bright for PayPal's ecosystem.)

Going Legit

The same week that PayPal announced its stablecoin, the Federal Reserve established its new "Novel Activities Supervision Program" to enhance the supervision of the banking organisations in its remit. It will focus on activities related to crypto-assets, shared ledgers and technology-driven partnerships with non-banks to deliver financial services to customers. The Feds says that this will be risk-focused and complement existing supervisory processes. I think that in this context, PYUSD will have its most significant impact on the market: Legitimising stablecoins as an activity for regulated institutions.

I think it is entirely consistent with the evidence to remain sceptical about the impact of cryptocurrency on the wider economy, while at the same time being excited about tokenisation and the transition to that web3 world of decentralised finance protocols exchanging digital assets backed by regulated institutions with digital currencies, similarly backed by regulated institutions. In this respect, PayPal’s move will I am sure be seen in hindsight as a cusp moment and a vote of confidence in the web3 world.