Will PayPal’s foray into stablecoins pay off?

Stablecoins are key to the growth of decentralised finance. While there are risks associated with digital tokens pegged to fiat currencies — as illustrated by the collapse of Silicon Valley Bank (SVB) — big technology and financial services firms are poised to enter the stablecoin arena, following in the footsteps of PayPal.

• PayPal launches a digital token, PYUSD, pegged to the US dollar, as the Fed moves to regulate stablecoin.
• JPMorgan facilitates first blockchain payment for European corporate clients using its own token, JPM Coin.
• How to invest in decentralised finance: the ARK Fintech Innovation ETF is up 8% in the past six months.

Digital tokens have the potential to disrupt the financial industry, but the transformation of the payment landscape won’t happen overnight.

Just last week, the Fed issued guidance to state banks detailing that they should obtain a non-objection from the US central bank before issuing, holding or transacting in dollar-based tokens, such as stablecoins. Those banks that want to engage in stablecoins need to be able to demonstrate risk management — by, for example, having guardrails in place to monitor and prevent cybersecurity risks.

Stablecoins are typically pegged to physical assets, such as commodities like gold, or fiat currencies, such as the US dollar. This helps the digital token to maintain a relatively consistent or stable price.

The announcement is part of “ongoing work to create greater clarity for all parties as financial services and related technologies continue to evolve”, according to a statement on the Fed’s website. The overarching goal is “to foster the benefits of financial innovation while recognising and appropriately addressing risks to ensure the safety and soundness of the banking system”.

The Fed’s announcement was published one day after fintech giant PayPal [PYPL] became the first global payments firm to launch its own stablecoin, PYUSD. The cryptocurrency is backed by US dollar deposits, short-term US Treasuries and similar cash equivalents, according to a press release.

PayPal’s stablecoin foray

“The shift toward digital currencies requires a stable instrument that is both digitally native and easily connected to fiat currency like the US dollar,” said PayPal president and CEO Dan Schulman.

PYUSD will initially be available within PayPal-owned Venmo and then between Venmo and PayPal’s eponymous app. The digital token will be redeemable for US dollars and then be used to buy and sell cryptocurrencies, including bitcoin.

Beyond adoption within the crypto community, PayPal is hoping that PYUSD will reduce friction for payments made in virtual environments and even support the digital economy by facilitating the direct flow of funds to developers and creators.

“Over time, going back to us as a payments company, we are interested in driving payment flows here that we will also be monetising in a number of ways that are beyond just strictly the monetisation of the reserve,” Jose Fernandez da Ponte, senior vice president of blockchain, crypto and digital currencies at PayPal, told Bloomberg TV last week.

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PYUSD adoption could be hindered by rising rates

PayPal isn’t the first major company to make a foray into stablecoins. Meta [META] did so back in 2019 with Diem (formerly Libra), but it was shuttered in early 2022 due to regulatory scrutiny.

With the Fed slowly warming to cryptocurrencies, PYUSD should be more successful than Diem. However, its longevity and growth will depend on adoption. The stablecoin doesn’t offer yield to users, and if this remains the case then it’s likely to face long-term “adoption headwinds as competition from central bank digital currencies and yield-bearing stablecoins increases”, argued Bank of America analysts Alkesh Shah and Andrew Moss in a note to clients seen by CoinDesk.

Shah and Moss explained that investors would have been happy to hold “non-yield bearing stablecoins” in a low-rate environment, but “yield-bearing stablecoins will likely become increasingly available and attractive with short-term rates above 5%”.

More big players could follow PayPal’s example

Other technology and financial services companies could be watching how PYUSD fares before they decide whether to launch their own stablecoins.

PYUSD will be issued by crypto brokerage Paxos, whose head of strategy, Walter Hessert, told CoinDesk TV last week that there were other “white label stablecoin opportunities in the works”. Hessert went on to say that he expects there will be similar announcements to PayPal’s, based on discussions Paxos has had with many large technology and financial services companies.

Beyond stablecoins, JPMorgan [JPM] recently facilitated the first blockchain transaction for a European corporate client, Siemens [SIE.DE], using its own digital token, JPM Coin, Bloomberg reported in June. JPM Coin has been used to process approximately $300bn worth of transactions since its launch in 2019, although this pales in comparison to the $10trn of transactions the bank processes on a daily basis.

Central banks unlikely to adopt stablecoins — for now

Mainstream adoption of stablecoins could be held back by their fragility and the fact they can be subject to market-value risk, as illustrated by the collapse of SVB; crypto firm Circle’s USDC fell from its dollar peg after the company revealed that $3.3bn of its $40bn in reserves were tied up in SVB.

Analysts led by Andrew O'Neill at S&P Global aren’t expecting major central banks to issue their own digital currencies in the near future. Nonetheless, stablecoins will be “necessary to the growth of decentralised finance (DeFi)”. Thus privately-issued stablecoins, such as PayPal’s PYUSD, “will be a necessary tool to enable use cases for DeFi”.

“In our view, it is likely that regulation will lead to the development of stablecoins that are issued by regulated financial institutions,” added the analysts.

How to invest in decentralised finance

ETFs, or exchange-traded funds, offer an economical and diversified way to invest in a variety of stocks within a particular theme.

Funds in focus: ARK Fintech Innovation ETF

The Global X Fintech ETF [FINX], which holds PayPal, is weighted in favour of the information technology (IT) sector (77.2%) as of 31 July, followed by financials, which has been allocated 13.4%. Industrials, communication services and healthcare all have single-digit allocations. The fund is flat over the past six months.

The Capital Link Global Fintech Leaders ETF [KOIN], which also holds PayPal, doesn’t offer a sector breakdown. However, it focuses on digital asset providers, companies that use technology to improve settlements and customer experience and create digital assets, and solution providers, companies that enable the financial services industry to adopt and implement the latest technology. The fund is also flat over the past six months.

The ARK Fintech Innovation ETF [ARKF] doesn’t hold PayPal. As of 30 June, 30.5% of the portfolio has been allocated to transaction innovations, with 19% and 16.6% allocated to customer-facing platforms and risk transformations, respectively. New intermediaries have a 15.9% weighting, while frictionless funding platforms make up 10.6% of the portfolio. Bitcoin and blockchain account for just 7.3%. The fund is up 8% in the past six months.