CBDCs vs Stablecoins: Replacement or Co-existence?
Digital currencies, specifically Central Bank Digital Currencies (CBDCs) and stablecoins, are triggering vibrant discussions worldwide about the future of money and financial systems. These digital assets, with their potential to foster greater financial inclusion, streamline payments, and extend financial systems into the digital realm, are poised to redefine our understanding of money. Yet, they also prompt serious queries about the stability and security of the financial system, the evolving regulatory landscape, and the possibility of displacing existing financial intermediaries.
Understanding CBDCs and Stablecoins
Central Bank Digital Currency (CBDC)
CBDC is a digital or virtual version of a country’s fiat currency, regulated and overseen by the nation’s financial authorities and government. CBDCs represent an effort by governments to regulate the burgeoning cryptocurrency sector and preserve the relevance of the conventional banking system, with primary objectives to:
· Guarantee secure, centralized payments
· Regulate the payment network
· Introduce reserve-backed digital assets into circulation
Stablecoins
Stablecoins are a genre of cryptocurrencies designed to minimize price volatility. They maintain stability by anchoring their value to other assets or a basket of assets, such as fiat currency, another cryptocurrency, or commodities with intrinsic value like precious metals. Key attributes of stablecoins include:
· Enhanced security and instant payment processing
· Price stability, as they are backed by reserves of fiat currency or other assets, mitigating volatility
· The ability for private payments
Fundamental Differences Between CBDCs and Stablecoins
While CBDCs and Stablecoins both represent digital forms of currency, they harbor several key differences:
· Regulatory arrangement: Stablecoins lack a central regulatory authority, whereas CBDCs are regulated by the central banks of their respective countries.
· Degree of centralization: Stablecoins operate on a decentralized network, whereas CBDCs are centralized, governed by the country’s government.
· Security features: Compared to CBDCs, Stablecoins may not have the same level of security especially if they are not regulated. CBDCs are expected to have stronger security features due to their direct regulatory backing.
· Backing arrangement: Stablecoins are typically backed by private money, whereas CBDCs are backed by government-issued money.
Both CBDCs and Stablecoins offer unique advantages and potential drawbacks. Understanding their differences and implications is vital for users navigating the evolving landscape of digital currencies.
Key Features and Functions of CBDCs and Stablecoins
CBDCs and Stablecoins, both forms of digital assets, are gaining significant attention due to their potential to reshape the global financial landscape. While they share the commonality of being digital, their unique features and functions set them apart.
CBDCs:
CBDCs are digital versions of a country’s fiat currency, issued and backed by the country’s central bank. These currencies are not tied to an underlying asset, but instead, mirror the value of the nation’s fiat currency. They are designed with the primary aim of facilitating payments across the economy, with several unique features and functions:
· Competitiveness: CBDCs can be more cost-efficient than physical cash due to lower transaction costs. They also facilitate quicker and more streamlined implementation of monetary policy.
· Reduced third-party risk: By eliminating the need for intermediaries, CBDCs can simplify the implementation of monetary policy and enable real-time delivery of government programs during crises.
· Fraud Prevention: By adopting cryptography and blockchain ledger, it could be easier for central banks to track money throughout their jurisdiction, improving fraud prevention mechanisms.
· Efficient Monetary Policy Implementation: Simplify and expedite the implementation of monetary policy, including the delivery of government programs during crises.
· Promotion of Financial Inclusion: Make financial services more accessible to the underbanked and unbanked populations, particularly in regions with underdeveloped banking infrastructure.
Stablecoins:
On the other hand, Stablecoins are cryptocurrencies that are pegged to the value of an underlying asset. They are primarily used to facilitate investments in the crypto market.
· Price Stability: Stablecoins are designed to maintain stable prices by pegging their value to underlying assets.
· Utility in Cryptocurrency Trading: They offer traders the ability to lock in profits without converting to fiat currency.
· Potential for Use in DeFi: Stablecoins can be used in the Decentralized Finance (DeFi) market to generate yields while mitigating market volatility.
· Value Storage: Investors may use stablecoins to temporarily store value after selling a particular cryptocurrency, avoiding trading fees associated with converting back to fiat currency.
· Global Transfers: As low-fee alternatives to traditional money transfer methods, stablecoins can facilitate global transfers without foreign exchange fees.
CBDC, Stablecoin, and Their Roles in Centralized and Decentralized Finance
CBDCs play a crucial role in reinforcing centralized finance (CeFi) due to their nature and design. As a digital form of a nation’s fiat currency, a CBDC is a direct liability of the central bank, which means the central bank is responsible for ensuring the security of the digital currency it issues. CBDCs are subject to national regulations and a country’s monetary policy, making them a central part of the existing financial system.
CBDCs could be minted on private ledgers and operated by financial institutions, adopting a ‘two-tier’ model where the CBDC is issued to banks for onward distribution to retail users. This model is currently proposed by most CBDC projects, including the “Aurum” project by the Bank for International Settlements (BIS) Innovation Hub Hong Kong Centre and the Hong Kong Monetary Authority (HKMA).
The BIS research distinguishes between different types of retail CBDC (rCBDC) architectures: Direct rCBDC, Hybrid CBDC, Intermediated CBDC, and Indirect architectures. A CBDC reinforces CeFi by enhancing the control of central banks and commercial banks over the money supply, ensuring the stability and security of the financial system while promoting innovation within a regulated environment.
Stablecoins, on the other hand, are a type of cryptocurrency that is pegged to the value of an underlying asset, combining the benefits of cryptocurrencies, such as transparency and security, with the stability of traditional currencies to reinforce DeFi.
Key Concerns Regarding CBDCs and Stablecoins
CBDCs offer immense potential for revolutionizing financial transactions, but they also present several challenges:
· Privacy: The digitization of money makes transactions easily traceable, which consequently makes them taxable. This potential loss of privacy could dissuade individuals from adopting CBDCs, especially those who highly value their privacy.
· Technological Stability: CBDCs require a robust and reliable technological infrastructure to support the huge volume and frequency of transactions.
· Weak Business Case: The effort and resources necessary to develop CBDC infrastructure might not justify the perceived benefits. Several countries expressed that they currently do not see a compelling case for national digital currencies.
· Transaction Speed: Although CBDCs promise to enhance transaction speed, many developed countries have already implemented instant payments using existing infrastructures, thus diminishing the speed advantage proffered by CBDCs.
· Impact on Banks: The swift uptake of CBDCs could lead to a reduction in bank deposits as funds get diverted to digital cash. This would affect banks’ lending capacity and their ability to generate income from fees on these deposits.
· Risk and Financial Impact: CBDCs could affect bank liquidity and capital requirements due to potential policy alterations. There is also a need to develop safeguards against “digital bank runs” - a risk not currently addressed in the 24/7 cryptocurrency markets.
Like CBDCs, stablecoins’ implementation also confronts various challenges:
· Infrastructure Investment: Both stablecoins and CBDCs could necessitate significant infrastructure investment by retail banks, merchants, and payment service providers, potentially straining their development capacities.
· Regulatory Balance: Regulators and central banks need to maintain a delicate balance to ensure stability and consumer protection while avoiding stifling innovation and obstructing stablecoin use.
· Impact on Cryptocurrency Markets: The introduction of CBDCs could disrupt cryptocurrency market dynamics, thereby impacting investors in this highly speculative asset class.
· Societal Impact: The adoption of stablecoins and CBDCs will have profound effects on society. Uncertainties linger about the future use of physical cash, the nature of transactions, and individuals’ comfort level with traceable payments and traditional banking services.
The Future of CBDCs and Stablecoins
Speculation around CBDCs Replacing Stablecoins
The future trajectory of CBDCs and their potential to replace stablecoins remains uncertain due to the nascent state of this technology and the complexity of the financial systems within which they operate. The endgame for CBDCs and stablecoins depends on numerous unresolved factors, including the priorities of central banks (retail vs. wholesale, domestic vs. cross-border), and the pace at which national agencies regulate stablecoins before issuing their own CBDCs.
CBDCs and stablecoins differ in their design, issuance, and applications. Traditional financial institutions, cryptocurrency investors, and commercial banks should anticipate the impact of CBDCs on their operations and strategies.
The Possibility and Implications of CBDCs and Stablecoins Co-existing
A plausible scenario is the co-existence of CBDCs and stablecoins, each serving distinct purposes within the financial system. However, this coexistence is not without challenges. The regulatory landscape for digital currencies is still evolving, and the issuance and use of stablecoins could face increased scrutiny and regulation.
The future of CBDCs and stablecoins is likely to be shaped by a complex interplay of regulatory decisions, market conditions, and technological developments. While it is too early to predict the outcome definitively, it is clear that digital currencies have the potential to significantly transform the global financial system.
