Stablecoin Sandwiches and FX – Would You Like Fries with That?

Foreign exchange flows are heavily reliant on trade flows – this is the argument that has allowed currencies to be “different” from a regulatory perspective. After all, long-term investors make stock market bets, speculators use derivatives and the FX market rides on real business and cross-border trade and payment flows.

So what happens when you enter so-called stablecoin sandwiches into the equation? In a recent speech, Christopher Waller member of the Board of Governors of the Federal Reserve System said at A Very Stable Conference in San Francisco, that stablecoins are gaining ground as a means of cross-border payments.

“We are hearing increased industry focus on the “stablecoin sandwich” model of cross-border payments, in which fiat currency in one country is converted first into a US dollar stablecoin, then that stablecoin is transferred to another individual, and then finally the stablecoin is converted back into the local fiat currency at its destination,” Waller told the audience.

The $220 billion stablecoin market has grown rapidly, notching up more than 60% of market cap growth in the past 12 months. Nearly the whole of this market is composed of dollar-pegged stablecoins, dominated by Tether which has approximately 64% of the overall space and it’s grown so big that it ranks as the 18th largest holder of US government debt.

Apart from trading, stablecoins matter from an FX perspective because they allow participants to send money across borders without going through the labyrinthine correspondent banking system, cutting down on time and costs. By using stablecoins, FX transactions can be reduced to settling within an hour, rather than in two days, while costs are cut and the FX risks taken are also significantly reduced due to the compressed time horizons.

“This has the potential to reduce the complexity of a series of correspondent banking networks, improving transparency, cost, and timeliness. As this use case develops, it is critical that market participants implement all anti-money laundering and relevant consumer safeguards,” Waller added.

It’s true, the share of stablecoins is still small relative to the size of FX markets but the trend is pointing towards more growth, not lack of. Of the 20 largest payment companies in the world, 18 are experimenting with stablecoins one way or another. Bank of America recently revealed that it uses stablecoins for transactions within the bank, and considering the size of the global cross-border payments industry, stablecoins have a long way to go. McKinsey estimates that in 2023 the global payments revenue pool was in the magnitude of $2.4 trillion, across 3.4 trillion transactions.

According to Visa’s stablecoin dashboard, some $6.2 trillion worth of transactions used stablecoins for payments in the past 12 months, across 4.9 billion transactions, and as the US moves away from central-bank issued digital currencies and supports stablecoins instead, these numbers look set to go higher.

This is especially true considering the increasingly weaponised nature of currency markets and settlement. Stablecoins also play a role in shaping the future of the dollar’s dominance, according to the Atlantic Council, which wrote in a blog that these digital coins have the potential to reverse the twenty-year trend of de-dollarisation.

While the dollar remains one part of FX trades in 88% of transactions, the share of the greenback in reserves has been declining markedly since the turn of the millennium, despite the relative strength of the dollar in the period. In 2000, dollars made up more than 70% of global reserves, compared with a whisker over 57% in the third quarter of last year, based on data from the International Monetary Fund.

The move away from the US currency has also been broad, according to the IMF, which noted that in 2022 there were 46 active diversifiers, defined as countries that have a share of non-traditional currencies of at least 5%. By 2023, at least three more joined the list.

“Taking a longer view, over the last two decades, the fact that the value of the US dollar has been broadly unchanged, while the US dollar’s share of global reserves has declined, indicates that central banks have indeed been shifting gradually away from the dollar,” the IMF said.

Enter individuals. The Atlantic Council argues that while central banks have been moving away from the buck, stablecoins allow demand from the people to filter through. “In this context, choices made by individual users can materially impact global reserve currency status. The broad adoption of US dollar-backed stablecoins could even reverse the de-dollarisation trend.  Decisions made by policymakers during 2025 will thus materially impact how the stablecoin and dollar markets evolve,” the AC said.

So why does all this matter for FX trading? If market participants adopt dollar-pegged stablecoins on a broad scale for payments and other FX transactions, market infrastructure will have to change to accommodate “the digital dollar” on rails and that might translate into thinner margins.

Would you like fries with that?

eszalay@thefullfx.com