The mechanics behind stablecoins are diverse, reflecting the different approaches to achieving price stability. The most common type is fiat-collateralised stablecoins, which are backed by reserves of fiat currency held in a bank. For example, Tether (USDT), the most widely used stablecoin, is pegged to the US dollar and claims to be backed by a reserve of assets equal in value to the amount of USDT in circulation. Tether’s market dominance, with a market share of 69% of the total market capitalisation of all stablecoins according to Forbes, underscores the demand for a stable, dollar-pegged cryptocurrency.

Main stablecoins - Market cap over time

Source: CoinGecko

Another significant player in the stablecoin market is USD Coin (USDC). Issued by the Centre Consortium, which includes companies like Circle and Coinbase, USDC is also pegged to the US dollar and is fully backed by dollar reserves. Unlike Tether, USDC undergoes regular audits by independent accounting firms, providing an additional layer of trust for users. This transparency has made USDC a preferred choice for institutional investors and businesses looking to leverage stablecoins for everyday transactions, cross-border payments and DeFi applications, (as underlined by the increase of USDC market capitalisation growth of around 32% since September of 2023.

The algorithmic stablecoin is another innovative approach within this space. Unlike fiat-collateralised stablecoins, algorithmic stablecoins maintain their peg through algorithms that automatically adjust the supply of the token in response to market demand. TerraUSD (UST), which was one of the most prominent algorithmic stablecoins, maintained its peg by incentivising users to either mint or burn tokens based on the market price. Although TerraUSD ultimately failed in maintaining its peg, leading to its collapse in 2022, the concept of algorithmic stablecoins remains a key area of interest and experimentation within the blockchain community. The failure of TerraUSD also highlighted the risks associated with algorithmic models, particularly in how they respond under stress conditions, prompting more rigorous debate and innovation in the sector.

Financial inclusion, the effort to make financial services affordable and accessible to all, remains a pressing challenge in many emerging economies. According to the World Bank, one of the main obstacles is the high cost of banking services, driven by limited competition and the dominance of a few large institutions. Moreover, changing regulations around cross-border transactions have made it harder for banks to maintain remittance service partnerships. As the Bank for International Settlements (BIS) reports, the number of correspondent banks fell by 25% between 2011 and 2020, further reducing access to the global financial system. This has led to increased costs and frictions in cross-border payments, painting a crucial issue, as remittances often play a more significant role in these economies than development assistance.

Faced with these barriers, many individuals and businesses are seeking alternative and stablecoins offer a promising solution. By providing a more efficient, cost-effective, and stable means of transferring money, stablecoins can help bridge the gap left by traditional banking systems. In doing so, they offer a pathway to greater financial inclusion, broader access to essential services, and the potential for economic growth and stability in emerging markets.

While private stablecoins have led the charge in the digital currency revolution, central banks around the world are not standing passively by. The rise of stablecoins has caused many central banks to explore the development of Central Bank Digital Currencies (CBDCs), which represent a digital form of a country’s sovereign currency. Unlike private stablecoins, which are typically issued by corporations or decentralised organisations, CBDCs would be issued directly by central banks, giving them the full backing and credibility of the government, just as their respective fiat currency. This has important implications for the global financial system, as CBDCs could fundamentally alter the way money is issued, transferred, and managed.

China has been the most proactive in this regard, with its digital yuan, known as the e-CNY, already in advanced stages of development and testing. The People’s Bank of China (PBOC) has conducted extensive trials across multiple cities, with millions of yuan in digital currency distributed to citizens and businesses. The digital yuan is designed to work seamlessly with existing financial infrastructure while also enabling direct peer-to-peer transactions without the need for intermediaries. This could significantly reduce transaction costs and increase the efficiency of payments, particularly in a country like China, where mobile payments are already deeply integrated into daily life.

The implications of the digital yuan extend beyond China’s borders. If widely adopted, the e-CNY could challenge the dominance of the US dollar in international trade and finance, particularly in regions where China has strong economic ties, such as Africa and Southeast Asia. The digital yuan could also provide a way for countries to bypass the SWIFT system, which is currently dominated by the US, thereby reducing their exposure to US financial sanctions. This geopolitical dimension of CBDCs adds an additional layer of complexity to their development and adoption, as they could become tools of economic influence in the hands of states.