The new Layer 1 networks being rolled out by organizations like Stripe and Circle are the first blockchain networks that settle natively on stablecoins rather than cryptocurrencies like bitcoin or ether. They remove the need for entities to hold a volatile token to pay for blockchain transfers, and this could have a huge impact on these transactions.
A new report, Stablecoin-Focused Networks: Another Step Toward the Mainstream, looks at how financial institutions can take advantage of these emerging blockchain networks. “One of the biggest things about these stablecoin Layer 1s is that they remove the need to hold a volatile token,” said Joel Hugentobler, Cryptocurrency Analyst for Javelin Strategy & Research and the lead author of the report. “That’s huge. I don’t think that can be overstated.”
Tamping Down the Volatility
If a company like American Express wants to send a payment on a public blockchain like the Solana network now, it has to hold assets in Solana. One major concern with this is the volatility of Solana’s price—it could be worth $200 today and $100 tomorrow. Because of this volatility, many financial institutions have resisted adopting blockchain transactions.
The new Layer 1 networks instead employ a network settled with stablecoins. Instead of using Solana or Ethereum or another type of cryptocurrency whose value can fluctuate wildly, they’re using stablecoins.
“The elimination of volatility is important from a balance sheet perspective,” Hugentobler said. “You’re looking at hundreds of billions of dollars being transferred from any given set of companies in a day. That adds up.”
Capacity Concerns
There are other problems with the existing blockchain networks. Solana, for example, has had its Firedancer upgrade set to come out for a while, which is supposed to increase its throughput to a million transactions per second. That has yet to happen, leaving the existing blockchains with fairly limited throughput.
“When you use Ethereum or Bitcoin, you still run into the same issue, especially during periods of high volatility, which is network congestion,” Hugentobler said. “What the market has been saying is that there’s an issue with holding volatile tokens and not enough throughput. The market has been saying we need Stripe and Circle and likely the others to follow.”
Solana’s network, for example, now processes roughly the equivalent of what Visa has been doing, around 60,000 transactions per second. For a long time, Solana has been expected to unlock the Firedancer upgrade, which upgrades the validator set and has the potential to increase throughput to 1 million transactions per second.
‘It was supposed to come out in Q3, but they keep pushing it back,” Hugentobler said. “Obviously, there’s some issues there, but that high of throughput would solve a lot of issues. But there are still issues on the side of compliance, knowing your customer, and dealing with issues that you can’t really undo on a blockchain.”
Issues to be Overcome
Another issue is limits for the financial institutions using them, aspects that they need to conduct their business. As with other blockchain transactions, the transfers of money are irrevocable on a Layer 1 network.
“If you send a payment to a wrong address, you can’t just call them and say, ‘Hey, I need help,’” Hugentobler said. “There’s limited tooling for compliance or know-your-customer applications. It can be done, but it’s just a lot more developer work on the company side.”
The need for privacy opt-in optionality and other functions for financial use cases is clear, and without those functions, Layer 1s will simply not be used by financial institutions. A payments-focused or stablecoin-focused blockchain allows entities to leverage the public or decentralized blockchain as it’s built from the ground up. But it also has hybrid characteristics, like the private network type of characteristics that can help alleviate KYC concerns. These limit the privacy capabilities in areas where financial institutions may not want pertinent information made public. These new Layer 1s aim to increase not only throughput but also tooling and optionality, right from the outset.
Tempo, Stripe’s entry into this business, is an attempt to solve these issues while offering the extremely high throughput necessary for payments. The design is combined with a stablecoin-native design, which means that instead of having a blockchain’s native token, a stablecoin pegged to a fiat currency will be used, eliminating the price fluctuation issues.
What FIs Should Do Now
There are real benefits to financial institutions that move into Layer 1 networks early. As the industry heads down the road of tokenization, companies that aim to use and leverage Layer 1 networks stand to gain a greater understanding of how the networks work together with all their moving parts. Hugentobler recommends that financial institutions employ a hands-on approach, which could entail using a Layer 1 network directly or setting up nodes to validate networks.
He also urges financial institutions to pay attention to their developer communities. Layer 1s that create and maintain their developer communities are likely to have more robust security protocols, throughput execution, and institutional-grade solutions. In evaluating new Layer 1s, entities should consider the communities that use them to help determine which layer or product to use.
“Getting in early and being fully involved doesn’t just give the corporation a better understanding of the process,” Hugentobler said. “Whether it’s collaborating with or even just building relationships with some of these infrastructure players, companies stand to have a voice in how the network can be developed or how it will evolve.
“It can put them in a position to influence development, and affect the regulatory fronts, all that sort of thing. At the end of the day, companies need to have skin in the game.”
