Why The US May Respond to Increasing Stablecoin Adoption with a CBDC
The United States Congress is in between a rock and a hard place as the United States Treasury Secretary warns of a looming debt crisis. Meanwhile, China’s largest property developer Evergrande has had the trading of its shares halted in Hong Kong. During one of the most financially tense circumstances in modern history, digital currency and cryptocurrency have taken the main stage yet again. This time around, media outlets globally are consistently covering the potential benefits and downfalls of blockchain-based phenomena, encouraging mainstream understanding and perhaps the adoption of the nascent technology. Whether or not these massive financial issues will lead to massive change or not is yet to be seen, but technological developments and consumer adoption seem to make global leaders uncertain about the future of the global monetary system.
G-7 central bankers and finance officials expressed their concern for the increased interest and use of digital currency in late 2020. More specifically, German Finance Minister Olaf Scholz declared Facebook’s upcoming digital currency project Diem to be a significant market risk stating, “A wolf in sheep’s clothing is still a wolf… It is clear to me that Germany and Europe cannot and will not accept its entry into the market while the regulatory risks are not adequately addressed”. Furthermore, Scholz stated that the G-7 “must do everything possible to make sure the currency monopoly remains in the hands of states”. This statement came at a time when cryptocurrency markets were booming and making headlines worldwide.
Stablecoins, a specific class of digital currency, pose a very direct threat to the monetary masters of the world. Used to peg the value of a dollar or any other stable value through collateralization, stablecoins allow anyone with internet access to transact with one another peer-to-peer, or without the use of an intermediary such as a bank or any other financial institution while maintaining the stability of the traditional currency system. This can help to significantly reduce market risks traditionally associated with cryptocurrencies. Instead of leveraging banks for this process, these financial transactions can occur on the blockchain itself. This means that over time, commercial banks and even central banks could be cut out of the equation when it comes to facilitating transactions and the creation of money if there is no response.
Decentralized finance (DeFi) is an umbrella term that encompasses blockchain innovation that enables global citizens to circumvent traditional financial infrastructure using purely internet-based protocols. DeFi allows internet users to borrow and lend and therefore earn a yield on digital assets, including stablecoins, at rates that are based on open market supply and demand. This challenges traditional banking in general because DeFi protocols are permissionless and can be used by anyone that has an internet connection. Instead of going into a local banking branch to set up a banking or brokerage account, anyone can set up what is known as a web 3.0 wallet to use these decentralized financial services.
Stablecoins are a key product of DeFi invented to protect investors from the volatility of cryptocurrency markets by providing a stable value for investors to trade into without needing to convert funds to fiat currency or transfer funds into a bank account at all. Holders can also use stablecoins to provide liquidity to the trading of other types of digital assets and earn an income for doing so. Stablecoin trading and utility is available 24/7 as cryptocurrency markets trade continuously, potentially creating more efficiency across digital asset markets. This widely-accessible alternative to assets that provide stable value and income opportunities is a real threat to fiat currency and traditional financial infrastructure around the world as options for stablecoins are plethoric and access to stablecoins is practically ubiquitous.
Realizing the faults in traditional financial infrastructure through incidents like the Robinhood scandal in February, DeFi and stablecoins create an opportunity for citizens that is difficult for the largest institutions of the world to ignore as information about these alternatives spreads rapidly. The increase in permissionless lending and borrowing of digital currency and specifically stablecoins speaks numbers, and it may suggest a new era of finance that the world’s most powerful economies are indicating that they are ready to respond to.
The United States Treasury has particularly been very vocal about its stance on stablecoins this year. As the value of stablecoins reached a market capitalization of $125B earlier this year, US Treasury Secretary Janet Yellen urged the United States to establish a regulatory framework for stablecoins citing the lack of supervision and transparency of issuers. This comes as a surprise to many in the digital currency space as stablecoins typically make use of blockchain technology which is inherently open and transparent.
Made possible through the invention of private blockchain technology, Central Bank Digital Currencies or CBDCs are generally defined as a tokenized version of fiat currency that is state-issued and they may represent a way for sovereign nations to maintain their monopoly over money. Described by HSBC Global Economist James Pomeroy as a “distant cousin to cryptocurrencies like Bitcoin”, CBDCs are closed and permissioned systems that differ from today’s financial architecture by creating a way for citizens and private institutions to interact with state-issued money with the government more directly instead of through commercial banks or technology providers by proxy.
Through public-private partnerships with technology providers, government bodies and central banks are able to build interoperable solutions that connect traditional banking systems to blockchain networks while maintaining control of who digital fiat currency and CBDCs may be used by and how they may be used. By issuing a CBDC, governments can prevent citizens from excessive exposure to the market risks of stablecoins and DeFi holistically through the production of a regulated point of access to decentralized protocols where greater transparency and oversight can be established. Greater transparency, oversight, and the elimination of the need for intermediaries are benefits that mirror those of cryptocurrencies, and because of this CBDCs may be a way for governments to offer a fair alternative to stablecoins and DeFi.
Federal Reserve Chair Jerome Powell has stated that he is unsure of the need for a central bank digital currency or CBDC in the United States this year. Noting that financial institutions around the world are developing solutions for multinational CBDCs, Jerome Powell’s words may signal that the Federal Reserve has been actively considering the need for a state-issued digital currency. Pilots announced by the Digital Dollar Project, led up by former Commodities Future and Trading Commission Chairman Chris Giancarlo, are yet another initiative that emboldens the reflection of the need for a CBDC by the United States and other powerful economies. To top it off, according to the Bank for International Settlements, 80 percent of the world’s central banks have already started to conceptualize and research the potential of Central Bank Digital Currency (CBDC), 40 percent are building proofs-of-concept (PoC), and 10 percent are already deploying pilot projects.
Whether or not the contemplation of deploying a CBDC is a response to the global market risks that stablecoins bring is unknown, but without an alternative to the distributed and permissionless nature of stablecoins, traditional digital fiat currency is slowly losing market share. China’s most recent ban on cryptocurrency reveals its stance on decentralized protocols, but may also expose its plans to fully roll out the launch of its own state-issued digital Yuan. Only days after China announced its ban, Jerome Powell made it clear in his congressional testimony that the Fed has no plans to ban cryptocurrency, setting the stage for a race to respond to the rapid adoption taking place. Meanwhile, the G-7 announced that they have officially reached an agreement on guidelines for central bank digital currencies.
US Treasury Secretary Janet Yellen’s warning of the looming debt crisis may also be worthy of noting to consider what the world’s top economic leaders will do next to protect the global monetary system. Yellen’s decision to decline to take calls from the head of the International Monetary Fund after a scandal in China and US congress’s call for “full accountability” in World Bank data may signal that the United States is ready to make a drastic change on its own. Predicting how and when a CBDC will be released by the United States is rather burdensome as it is clear that whatever plans around such are likely being concealed. Despite the cloaking of specific plans or ideas, it is likely that developments that come from the United States Treasury, Federal Reserve and other powerful financial institutions in the coming months will clear a path forward for the future of stablecoins and CBDCs.
