Should Western Union Worry About Stablecoins?

Remittances are small transfers, usually $1,000 or less, that people living in diaspora make to loved ones back home. These payments have become a vital form of survival not only for families left behind, but also for the developing countries themselves, which over the years have received shrinking amounts of development assistance and direct investment. Total remittances have reached $589 billion this year, according to the World Bank.

J.P. Koning, a CoinDesk columnist, worked as an equity researcher at a Canadian brokerage firm and a financial writer at a large Canadian bank. He runs the popular Moneyness blog.

At the moment, stablecoins are used mostly in the speculative crypto economy, not the bricks and mortar economy. Cryptocurrency exchanges that lack access to the banking system rely on stablecoins such as tether (USDT) and USD coin (USDC) as substitute proto-dollar accounts. Stablecoins also serve as the building blocks for decentralized financial (DeFi) tools.

Significant real-world usage of stablecoins, particularly remittances, would be a big “get” for the stablecoin sector. But there are some big challenges to address before this happens.

To be fair, crypto does already serve as a remittance vehicle, albeit a niche one. In a recent paper, economists Ken Rogoff, Carmen Reinhart and Clemens Graf von Luckner found that a lower-bound of 1.3% of all trades on LocalBitcoins, a peer-to-peer exchange, were related to usage of bitcoin for cross-border payments. The authors note that bitcoin remittances often involve countries like Nigeria that have exchange controls, which bitcoin is useful for evading.

The advantage that stablecoins have over bitcoin is that they don’t suffer from bitcoin’s wild volatility. Indeed, remittance company MoneyGram is currently experimenting with them.

The first of the two major hurdles to ubiquitous stablecoin remittances is the double-hop problem.

The double-hop problem

Much of the world lives in a bank account world. Our salaries arrive in our bank account. We purchase our necessities like shelter or food with a debit card or bank transfer.

Everyone else lives in a cash world. We earn money in cash and buy stuff with physical currency.

But no one lives in a stablecoin world. Except for a few privileged denizens of the crypto economy, no one receives a salary in stablecoins. Certainly no one buys supper with them. (Using a crypto-linked payment card to make purchases doesn’t count, since these cards sell crypto for fiat at the last instant and pay with bank money.)

Read more: Ripple to Deliver First Real-Time Payments From Oman to India Using Blockchain

This is the core of the problem. For most of the world’s remittance users, a stablecoin remittance forces them to temporarily leave their preferred financial environment. A sender must jump out of cash or bank accounts onto stablecoin rails. The person who receives the stablecoins must then hop back into the world of bank accounts or physical cash.

These extra hops are inconvenient. First, they require a certain level of technical and financial expertise to expedite. No internet access? Forget about it. Secondly, they are expensive. A hop into and out of stablecoins doubles the foreign exchange transaction fees involved in remitting money.

In her recent testimony to the U.S. Senate, financial regulatory expert Alexis Goldstein crunched how much the stablecoin double-hop costs. Using the U.S.-to-Europe remittance corridor as her example, Goldstein found that a remittance sender in the U.S. who buys $200 worth of tether stablecoins with dollars on Coinbase must pay a fee of $2.99. The $200 is then sent to a European recipient, who must pay $2.99 to sell tether on Coinbase for euros.

That’s already $6 in fees. Goldstein’s numbers didn’t include slippage – the gap between the bid and ask price for tether on Coinbase – which amplifies the all-in costs of a stablecoin remittance.

By contrast, a traditional $200 remittance carried out by Wise, MoneyGram or Western Union is just a single-hop transaction. Dollars must be sold for euros, and that’s it. A single-hop will always be cheaper than a double-hop.

The user fee problem

The double-hop problem that bedevils stablecoin remittances is compounded by the user fee problem. Platforms like Ethereum that are based on proof-of-work require that crypto miners be paid a fee to validate transactions. At the time of writing this article, it would have cost me a whopping $23 in mining fees to transfer $100 worth of USDP stablecoins that I own. That’s an awfully pricey remittance.

Read more: JP Koning - The Race for Stablecoin Transparency

The user fee problem can be avoided by dispatching stablecoin remittances over Ethereum’s emerging layer 2 architecture, say the Optimism or Polygon protocols. However, graduating stablecoins from the main level of Ethereum over to layer 2 and back down again incurs costly mining fees. It is also technically complex and takes time.

Competing blockchains Tron, Avalanche and Solana offer an alternative route for avoiding Ethereum’s user fee problem. These blockchains rely on proof-of-stake for security, which is much cheaper than proof-of-work.

But even if the parties to a remittance manage to route a stablecoin in a way that minimizes the user fee problem, the nagging double-hop problem remains. The jump into stablecoins and back out again will always be more costly than a single-hop remittance.

A few developments might minimize the double-hop problem and help make stablecoin remittances more competitive with regular ones.

Banks and stablecoins closer

One way to solve the double-hop problem would be a tighter fusion between stablecoins and bank accounts. If banks allowed customers to automatically withdraw stablecoins from their accounts without a fee (like we already do with cash), and also freely deposit stablecoins, then people making stablecoin remittances would no longer have to pay double the fees.

For example, say that Manuel – an immigrant living in the U.S. – wants to send money to Maria in Honduras. He’d start by withdrawing $200 in Wells Fargo-approved stablecoins from his Wells Fargo bank account, for free. He then sends them to Maria, who deposits the $200 worth of stablecoins directly into her Honduran bank account at no charge. Maria then asks her bank to convert the funds into Honduran lempira so she can pay rent. This foreign exchange swap is the only transaction in the entire circuit that incurs a bank fee.

While no-fee bank-to-stablecoin transactions would allow for cheap remittances, it’s not evident that this option will ever emerge. Banks don’t want to lose business to stablecoin issuers, after all, unless they themselves are the issuer of stablecoins.

Stablecoins invade the real world

A second way to minimize the double-hop problem would be to increase the number of real-world situations where stablecoins are accepted.

Read more: Crypto Remittances Prove Their Worth in Latin America

If Manuel’s real-world U.S. salary was paid in stablecoins, say tether, then he wouldn’t have to do a U.S. dollar-to-tether conversion when he sends a remittance to Maria. Alternatively, if Maria could purchase food and other basics with stablecoins, then she wouldn’t have to do a stablecoin-to-lempira conversion.

Broadening the range for real-world stablecoin transactions is not as easy as it sounds. What makes a payments network useful is the fact that other people are already connected to it. Lacking an initial set of users, a new payment network’s chances of breaking through are tiny.

Growing the crypto economy

If real-world acceptance of stablecoins is unlikely to occur, there’s a third way towards stablecoin ubiquity: increase the amount of people inhabiting the nascent crypto economy.

Right now the crypto economy is occupied by crypto fans, speculators and people who work in the industry. If there were more things to do in the crypto economy – entertainment, job opportunities, socializing – then people would increasingly “immigrate” there from the real world. New arrivals would be obliged to adopt the de facto payments standard, stablecoins.

If Bob, who occupies one region of the crypto economy, wants to remit $200 to Alice in another region of the crypto economy, USD coin or tether are the most convenient options. Interposing a non-blockchain intermediary like Western Union into the mix would be a step backwards. That would introduce an expensive double-hop, much like a stablecoin remittance in the real world introduces a double-hop.

For now, the double-hop and user fee problems prevent stablecoins from being a competitive remittance vehicle. Plenty of work remains to be done if they are to ever get to ubiquity.