Revisiting settlement finality: How public blockchains and stablecoins streamline everyday transactions
The ability of stablecoins to transform everyday payments, remittances, and financial access is a reality. From streamlining humanitarian aid disbursements to refugees in Ukraine to facilitating secure, cashless payments to workers in rural Colombia, stablecoins offer a powerful alternative to traditional payments.
They provide a global digital asset that needs a global infrastructure to move seamlessly and securely across borders. And that's what blockchains can do. Regulators and international policymakers, however, have recently manifested skepticism on the suitability of stablecoins running on open, public blockchains, networks that don’t have a central point of control and allow anyone to join and participate.
The general claim is that features of public blockchains’ operating models and the lack of a controlling entity prevent public blockchains from offering the stability, security, and resilience required from infrastructures used for payments and financial transactions.
A specific element of this general claim is that public blockchains cannot consistently provide settlement finality for stablecoin transfers. However, a closer examination shows that public blockchains are ready to provide a robust infrastructure for the financial needs of the digital world.
Public blockchains are similar to the real-time gross settlement (RTGS) systems many jurisdictions currently use. RTGS systems process transactions in real-time, with each transaction settling individually and not netted against other transactions, to avoid settlement risk. Transactions completed on a public blockchain can yield similar results with the added benefits of transparency, increased availability, and faster settlement time.
Before delving into blockchain finality, let’s dispel some misconceptions about settlement finality, which tend to wrongly conflate settlement finality with instant processing and protection in bankruptcy. First, settlement finality does not require instant settlement but irreversibility, in the sense that after a transaction is finalized or settled, from a technical and legal perspective, no one can reverse, delete, or otherwise change it.
Irreversibility is only achieved when funds or assets flow from one account to the other, regardless of when the transaction was initiated by being broadcasted to the network. In terms of settlement finality, whether these two moments happen in instant succession or after some time is all but irrelevant.
The second clarification regarding settlement finality is that this status does not prevent a bankruptcy court–or any court for that matter–from deciding that a settled transaction is void and must be reversed because of creditor preference, error, or fraud. Technically, though, the court’s directive is not to “undo” the original transaction but to initiate a new transaction that reverses the effects of the original one, resulting in two separate and final transactions.
An example can help. A payment of $100 from Joe to Anna is Transaction 1 and becomes final and settled after 20 minutes. Six months later, a court rules that Transaction 1 was fraudulent and orders that it must be undone. A new payment of $100, this time from Anna to Joe, Transaction 2, has to be made, moving the same amount back and canceling the effects of Transaction 1. Note that after the original transaction (Transaction 1) is settled, it becomes permanent, and only a new second transaction can undo its monetary and financial effects (Transaction 2).
The effects of settlement finality are never absolute, not even in traditional financial infrastructures. Courts always have the power to correct transactions made in error, with fraud, or against applicable rules.
With these two points made clear, we can get back to blockchain finality. The fundamental point is that settlement finality is an essential part of public blockchains. At their core is the process of validating transactions and putting them in a new block that is then added to the chain so that the transactions it carries become immutable, gaining irreversibility.
But this process isn’t the same for all public blockchains. The way each blockchain works affects how and when the finality of transactions is achieved. So, to discuss blockchain finality, we need to look at blockchain governance, especially at how transactions are validated and how frequently each block of validated transactions is added to the chain.
For blockchains that rely on proof of work to validate transactions and create new blocks, like Bitcoin, finality is achieved in stages. As many miners compete to group transactions into a block, add the block to the chain, and receive the reward, some blocks might be added to the chain at the same time, creating a type of fork. But as only one block can be added to the chain every 10 minutes, only one of the simultaneous blocks will survive and remain connected.
Later on, as the next new block must be attached to the previous one, one block will receive the connection from the new one and stay on the main chain, and the other simultaneous blocks will be discarded. With that, the temporary fork will be solved, but all the transactions inside the discarded blocks will have to be resubmitted for a new validation and confirmation process.
So, the probability that a block is discarded and transactions inside them are reversed decreases as new blocks are linked on top of any block that remains on the main chain. The more blocks are added to the blockchain, and the more time passes, the less likely it is that previous transactions will change and the more “final” they become. That’s called probabilistic finality.
Standard-setting organisations like the Bank for International Settlements often question the instability of probabilistic settlement. However, no major fiat-backed stablecoin runs on proof-of-work blockchains. They run on public blockchains that operate with deterministic finality, which creates appropriate assurances for settlement finality.
The Stellar network is one such blockchain. As Stellar relies on proof of agreement to validate transactions and create blocks, finality is achieved in a single step, when each new block is added to the chain.
Validator nodes on Stellar don’t compete for a reward. They instead collaborate to create a widespread agreement about the validity of transactions and their addition to the chain through a new block. And all that is based not on the use of computational power and energy but on the reputation of the entities running validator nodes. Once agreement is reached among validator nodes, it’s final and cannot be reversed.
On Stellar, moreover, a block is added to the chain every five seconds, and it carries up to 1,000 transactions–a limit that can be adjusted. This means that the queue of pending and unconfirmed transactions on Stellar, known as "transaction queue” or “mempool,” lasts on average only five seconds. As a result, transactions on Stellar typically reach settlement finality every five seconds, creating little to no exposure to credit or liquidity risks for the transacting parties.
Note that even traditional instant payments systems involve some time between sending the transaction to the network and finally settling it. Pix, the Brazilian retail instant payments system launched in 2020, has rules requiring participants to settle instant transactions in under 40 seconds. This time can be extended to 30 minutes or even 60 minutes (for night transactions) if the Pix participant, a financial institution or fintech, suspects the submitted transaction might be fraudulent.
Note also that the widespread comparison between the number of transactions processed per second (TPS) on public blockchains and that on traditional financial infrastructures, like card networks, can be misleading. The usual argument is that while Visa can execute tens of thousands of TPS, Bitcoin can only handle 7 TPS and Stellar 200 TPS on average. Apples and oranges.
TPS for card networks refers to the number of screened and authorized messages requesting funds or assets to flow from account A to account B. The actual flow of funds and, in turn, settlement finality will only happen days later when the cardholder’s bank transfers the money that will end up in the merchant’s bank account–if a counter order, like a chargeback, doesn’t happen along the way.
TPS for public blockchains, on the other hand, refers to the number of transactions that complete the full cycle of being broadcasted, validated, and finalized, with funds or assets effectively changing from account/address A to account/address B–no matter where in the world these accounts/addresses are. TPS here actually implies settlement finality, as discussed.
No traditional financial infrastructure provides this kind of nonstop finality volume at a global level. And Stellar provides that for a fraction of a penny per transaction and in a sustainable way, as the network’s carbon footprint is equivalent to that created by the electricity use of 34 U.S. homes in one year.
For all these reasons, stablecoins running on public blockchains fully adhere to the relevant international standards and best practices that apply to traditional financial infrastructures regarding settlement finality. Public blockchains can offer the digital economy as much–if not more–stability, security, and resilience as any infrastructure used today for settling payments and financial transactions.
