The sources identify that fungibility is an overriding precondition for payment and settlement, which means that means of payments issued by different entities underpinned by the same unit of account are mutually interchangeable at face value. To analyze stablecoin fungibility for payments, the sources argue that stablecoins can only function as fungible means of payments if three core conditions are met.
These three elements, which are generally required for means of payment fungibility for retail payments, apply irrespective of whether the means of payment is predicated on account or token-based technologies:
- Settlement Finality.
- Interoperability.
- Seamless Convertibility into the "ultimate" or quasi-ultimate means of payment.
The paper asserts that for stablecoins issued by different issuers on different blockchains to be considered fungible (to the same extent as commercial bank deposits from different banks), the prerequisites of interoperability and settlement finality must be met, but true fungibility is only accomplished if central bank money acts as the anchor to the monetary system.
Core Requirements for Fungibility
1. Settlement Finality
Settlement finality is defined as the irrevocable and unconditional transfer of an asset or financial instrument, or the discharge of an obligation. It is crucial because it allows for a clear determination of the exact moment a transfer of value becomes final and irrevocable.
In the context of stablecoins, which rely on decentralized payment systems and consensus mechanisms:
- Proof-of-Work (PoW): Networks like Bitcoin achieve probabilistic settlement finality, where finality is based on the exponentially decreasing probability that a transaction will be altered as subsequent blocks are added (typically 3–6 blocks). This contrasts with the traditional definition requiring the ability to pinpoint the precise moment of irrevocability.
- Proof-of-Stake (PoS): Networks like Ethereum aim for deterministic finality, meaning a block, once finalized, cannot be changed or reversed under normal conditions, aligning more closely with traditional financial definitions. However, even PoS relies on a consensus principle, and a majority of stakeholders could, under exceptional circumstances, decide to fork the ledger, creating two diverging chains. In such an event, the stablecoin issuer must clearly communicate which ledger holds the legitimate claim to the underlying assets to ensure finality.
2. Interoperability
Interoperability is the technical or legal compatibility that allows a system to be used in conjunction with others, enabling participants to transact across systems without needing to join multiple systems.
For stablecoins, interoperability must be achieved in two directions: horizontal (between stablecoin ecosystems) and vertical (with traditional payment systems). The sources classify interoperability into three types: technical, semantic, and business:
| Type of Interoperability | Focus and Stablecoin Context |
|---|---|
| Technical | Implementing the same technical standards and protocols to allow seamless interaction. Lack of technical interoperability means different ledgers prevent direct interaction unless cross-chain solutions or bridges are used, which add complexity and risk. |
| Semantic | Ensuring systems interpret data uniformly (e.g., common transaction language/formats). Semantic failure can occur if stablecoins use different token standards on the same ledger, preventing smart contracts from correctly processing them. |
| Business | Agreeing on rights, obligations, and terms for clearing and settling (e.g., redemption rights, compliance standards, user access). This is the primary limitation for horizontal fungibility between stablecoins from different issuers. Disparities, such as different legal rights or policies on "tainted" tokens, limit the ability of stablecoins to be used interchangeably in all business contexts. |
To improve fungibility, issuers should aim to align with international best practices, maintain adequate reserves of high-quality assets, and ensure rapid, free redemption processes.
3. Seamless Convertibility
Convertibility refers to the ability of a means of payment to be readily redeemed at par into the pegged asset, which must be the "ultimate" or quasi-ultimate means of payment—central bank money (e.g., banknotes). Convertibility is crucial because it ensures that means of payments lower on the monetary hierarchy can be readily traded with those of higher credit quality.
The Role of Central Bank Money: Central bank money acts as the ultimate anchor because, by design, it is free of credit and liquidity risks, exhibits homogeneity, and is scalable. All other means of payments (commercial bank deposits, e-money, etc.) are "layered" on top of central bank money in a payment pyramid. For stablecoin convertibility, the issuer needs access to the financial system and must have the capacity to readily transfer the pegged asset so that end-users can redeem their stablecoins into commercial bank money (or eventually central bank money).
Stablecoin Fungibility for Payments (Core Analysis)
The fulfillment of these three requirements determines whether specific stablecoin types are considered fungible means of payments:
| Stablecoin Type | Fungibility Status & Conditions | Core Rationale (Convertibility) |
|---|---|---|
| Tokenized Funds | Fungible means of payments. | Must operate on ledgers offering credible settlement finality, have strong liquidity/capital, and be interoperable with traditional payment technologies. |
| Off-chain Collateralized | Fungible means of payments. | Must meet the same conditions as tokenized funds, and the issuer must have adequate capital to cover potential volatility in liquid off-chain assets in a stressed situation. |
| On-chain Collateralized | Prima facie fungible means of payments. | Must fulfill the core conditions, provided that the on-chain collateral can be readily converted into higher-level money (off-chain assets). |
| Algorithmic | Not fungible means of payments. | Algorithmic stablecoins rely on a protocol mechanism, not direct backing by a traditional counterparty. Therefore, end-users do not hold a claim on a counterparty that can facilitate convertibility into central bank money. |
In summary, means of payment fungibility for stablecoins hinges on fulfilling these three core requirements, ultimately necessitating that the asset maintains seamless convertibility into the monetary system's central anchor. This is analogous to how all rivers must eventually lead to the sea; regardless of how unique or efficient a river (stablecoin) is, its value and interchangeability are defined by its guaranteed connection to the ultimate reservoir (central bank money).
The sources analyze stablecoin fungibility for payments by establishing a taxonomy based on the stabilization mechanism and then determining if each type fulfills the three core requirements necessary for fungibility: Settlement Finality, Interoperability, and Seamless Convertibility into the ultimate or quasi-ultimate means of payment, such as central bank money.
The paper asserts that true fungibility for stablecoins is only achieved if central bank money acts as the anchor to the monetary system, assuming the central bank money is underpinned by a homogenous unit of account.
Stablecoin Taxonomy
The term "stablecoin" is a broad label for various crypto-assets that aim to maintain a stable value relative to a specific asset or pool of assets. The key distinctions relevant to fungibility are their use case, asset-backing model, and convertibility mechanism.
The taxonomy used in the sources categorizes stablecoins based on their stabilization mechanism and convertibility:
| Stablecoin Type | Stabilization Mechanism / Backing | Description |
|---|---|---|
| Tokenized funds | Commercial bank money (e.g., bank deposits). | Tokens backed by funds (e.g., commercial bank money) stored in a DLT ledger. These are functionally analogous to e-money constructs. |
| Off-chain collateralized | Off-chain assets other than cash (e.g., securities). | Backed by assets that require a custodian to hold them off-chain. |
| On-chain collateralized | On-chain collateral (e.g., unbacked crypto-assets, tokenized assets). | Backing is managed via smart contracts on-chain, relying on decentralized finance (DeFi), often over-collateralized. |
| Algorithmic | N/A (Protocol Mechanism). | Not backed by assets; stability relies on a protocol mechanism and the belief/expectation that the token can maintain its price stability. |
Fungibility Outcomes and Rationale (Core Analysis)
The fungibility outcome for each stablecoin type is determined by whether it can reliably fulfill the three core requirements, especially the crucial element of seamless convertibility into central bank money.
1. Tokenized Funds
Fungibility Outcome: Fungible means of payments.
Rationale: Tokenized funds are considered fungible means of payments provided that three conditions are met:
- They operate on ledgers that offer a credible mechanism for settlement finality.
- Issuers maintain sufficiently strong liquidity and capital positions to meet client obligations and regulatory requirements.
- The underlying payment and settlement technologies are interoperable with other traditional payment and settlement technologies. If these tokenized funds are issued by regulated e-money institutions, they may offer the necessary level of convertibility and can be considered fungible to the same extent as traditional e-money.
2. Off-chain Collateralized Stablecoins
Fungibility Outcome: Fungible means of payments.
Rationale: Off-chain collateralized stablecoins are deemed fungible provided they meet the same core conditions as tokenized funds (settlement finality and interoperability). Additionally, the issuer must hold adequate capital to cover potential variations in the volatility of liquid off-chain assets in a stressed situation.
3. On-chain Collateralized Stablecoins
Fungibility Outcome: Prima facie fungible means of payments.
Rationale: While generally considered fungible, this classification is contingent upon a critical premise. The identical preconditions associated with accomplishing means of payment fungibility for tokenized funds/off-chain collateralized stablecoins must be fulfilled. Most importantly, this type is only fungible on the proviso that the on-chain collateral can be readily converted into higher level money (i.e., off-chain assets).
4. Algorithmic Stablecoins
Fungibility Outcome: Not fungible means of payments.
Rationale: Algorithmic stablecoins are determined not to be fungible because they do not rely on direct backing by a "traditional" counterparty. Since their stability derives from a mechanism built into their protocol, end-users do not hold a claim on a counterparty that can facilitate convertibility into central bank money. The absence of an underlying mechanism to offer convertibility into some other asset means they fail the requirements for fungibility.
In summary, the sources establish that for stablecoins to be fungible means of payments, they must be reliable substitutes for traditional forms of money. This reliability is fundamentally tied to their position in the monetary hierarchy and their guaranteed ability to be converted at par into central bank money, either directly or through intermediate risk-free claims. Algorithmic stablecoins fail this test because they lack the necessary counterparty claim to ensure seamless convertibility.
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