The announcement in early August about a PayPal stablecoin may not quite have had the impact some had expected. Some criticized the lack of regard for pending
The adoption of applications like Apple Pay, Google Pay, PayPal, Venmo and merchant services like Stripe and Square offer payment convenience but little payment innovation. The services rely on conventional bank rails for processing payments. Similarly, the proliferation of cards has further deepened banks' role in payments as cards are typically issued and processed by banks. Banks, therefore, had relatively little to fear from the new services. They saw increased transactions, formed new partnerships and may have seen a reduction in fraud amid the security features of the apps. It has been a good deal for banks.
Banks dominate payments and payments represent a significant proportion of bank revenues. Most electronic payments involve banks. Banks hold reserves at the central bank to conduct wholesale or large value payments. Bank deposits are used to make retail payments. Banks thus either process payments or use bank instruments to conduct payments.
Banks have won against cash but the battle for nonbank digital payment instruments has only just started. Cash is issued by central banks and while end-users need banks to obtain cash, a transaction in cash does not involve the banks. The cash transaction, though, is in decline at least in most advanced economies. While it exhibits many interesting attributes, its use is limited to in-person payments. It is also expensive to maintain cash in circulation.
The possible introduction of central bank digital currencies (CBDCs) may revive the role of central banks in retail payments. CBDCs would most likely be distributed by banks similar to cash but use their own channels for processing payments. As with cash, banks would compete with CBDCs.
The innovation with stablecoins is the new medium — the digital token with properties akin to a bearer instrument — and new infrastructure — the blockchain — for processing and settling payments. They can be transferred peer to peer and can also include advanced features and functionalities to meet alternative payment demands. Stablecoins do not use banks or banking infrastructures. Stablecoins usually hold a reserve from the proceeds from issuance to meet future redemption demands.
While proponents of a central bank digital currency tout modernity and financial inclusion, House Financial Services Committee members of both parties fear lending could suffer under a digital dollar and are wary of handing the Federal Reserve even more power.
The new PayPal stablecoin therefore changes the relationship between payment service providers and banks. Though the PayPal stablecoin is actually not a PayPal stablecoin,
The impact of stablecoins on banks is twofold. On the payment side, if stablecoins use alternative infrastructures like blockchains, they do not need to rely on banks to process payments. On the reserve side, if the reserves are held in bank instruments like deposits, banks benefit from the issuance of stablecoins. If stablecoin issuers hold reserves in capital market instruments like government securities or money market funds, banks lose out. While stablecoins do not change the level of financial resources in the economy, they can shift financial resources away from the banks.
Payments are increasingly subject to greater diversification by actors, payment systems and mediums. Payment services can be provided by banks and nonbanks, use bank and nonbank payment channels and bank or nonbank payment instruments. While nonbanks will have to demonstrate they can offer better payment services, they do provide more choice for users, greater competition and potentially a more efficient payments environment.
The emergence of cryptocurrencies has given payments a little bit of a jolt. While much attention has been on instruments representing new units of account, like bitcoin and ether, the biggest impact may come from stablecoins that are like other national-currency-denominated payment instruments, and could simply replace existing payment channels. There is nothing to suggest that stablecoins — if adequately regulated — could not be as effective as bank deposits and money market fund shares.
Banks have been working on alternative payment instruments for some time. For example, tokenized deposits may allow banks to offer a token-based instrument to serve alternative payment systems and expand banks' reach beyond the conventional payment ecosystem. Tokenized deposits can exhibit features similar to a deposit and at the same time a payment instrument, when equipped with attributes like a check. It may offer new ways to conduct payments and in particular simplify international payments.
PayPal has signaled that the next generation of payments may be bank-free. The rules therefore will need to be clear. In principle, existing rules seem adequate if stablecoin issuers were to choose between becoming a bank or a money market fund. But some lighter structure seems adequate if stablecoin issuers focus on a single activity. Banks will need to respond forcefully if they want to remain at the center of payments. The PayPal announcement may not quite feel big, but the direction of impact for banks could be.
