The foreign exchange market is one of the largest markets in the world, but it also has several shortcomings, such as high costs and settlement risks. The correspondent banking model of FX settlements, where intermediaries are involved in transactions, raises the complexity and costs for end-users. With embedded finance.
If you're wondering "What is a stablecoin?", read this blog post first.
The Bank of International Settlements (BIS) has identified settlement risk as a concern that can result in significant losses and undermine financial stability. However, distributed ledger technologies have led to the growth of CBDCs and stablecoins, which adheres to the principles of robustness, openness, and transparency through its use of immutable computer code deployed on blockchains. This has the potential to address challenges faced by the traditional FX market, and is being explored by regulators through initiatives such as Project Mariana.
Project Mariana is a joint effort from the BIS, central banks of France, Singapore, and Switzerland to explore cross-border Central Bank Digital Currency trading and settlements using DeFi protocols.
Research from the exchange of major payment stablecoins, Euro Coin (EUROC) and USD Coin (USDC), through the Uniswap Protocol, a widely used automated market making protocol, has shown that on-chain exchange of the EUROC/USDC pair has surpassed $124 million dollars cumulatively with daily volume as high as $8.6 million exchanged on a 24-7 basis.
As shown, decentralized stablecoin trading has consistent liquidity throughout the week, including on weekends where on-chain exchange rates have traded within a few basis points of exchange rates observed in traditional markets, suggesting a reasonable level of price efficiency for this market avoiding heavy price fluctuations.
On-chain FX trading and settlement using DeFi technologies has the potential to address many of the challenges faced by the traditional FX market, such as slow settlement speeds, high costs, and settlement risks.
Small and medium-sized businesses (SMEs) often have a tough time managing their foreign exchange risk. Whether it's paying suppliers or employees in a different currency, or processing invoicing for goods and services denominated in a foreign currency, SMEs can face FX exposures similar to larger firms. Traditional methods of hedging can be expensive and might not be accessible to SMEs. But, have no fear, blockchain technology and stablecoins are here to help!
By allowing direct access to FX markets, blockchain-based solutions can help SMEs avoid the costs and complexities associated with intermediaries. Plus, the automated market makers commonly used in the blockchain space are perfect for smaller transactions, making them great for SMEs.
On top of that, on-chain foreign exchange offers near instant settlement and 24/7 availability, which can provide SMEs with significant cost savings and risk reductions. This is especially relevant for businesses that have regular cash flows denominated in multiple currencies, as it allows them to manage their exposure to FX risk in a more efficient and timely manner.
Overall, blockchain technology and stablecoins are a valuable tool for SMEs to manage their FX risk and improve their access to financial services. Say goodbye to the headaches of traditional hedging methods and hello to a world of cost-effective and accessible solutions. If you're interested, let's chat about embedding crypto as a service.
