CBDCs & Stablecoins | 2020 Recap

This is part one of my series reviewing 2020. The other entries can be found here: Part 1, Part 2, Part 3, Part 4, Part 5.

While the incredible success of Bitcoin and DeFi was both significant and obvious in 2020, the story with the greatest long-term implications may well be the comparatively quieter growth of stablecoins and CBDCs.

Libra / Diem

Facebook’s Libra had a relatively quiet year. Certainly, it was far quieter than it would have been if they’d launched as originally intended. Instead, they had what could be described as a year of transition. The Libra Association lost some member companies and gained new ones, and there were a fair few personal changes as well. Libra underwent a renaming, with the Libra Association becoming the Diem Association and their wallet subsidiary Callibra becoming Novi Financial, presumably in an attempt to further distance themselves from Facebook and the project’s early iterations that demanded the attention of so many regulators around the world.

Most interesting of all was Diem’s change in approach, which was outlined in the updated version of their white paper. They now plan on issuing multiple different digital currencies pegged to different government-issued currencies like dollars, pounds, and euros. This would set Diem up to provide the payment rails for different Central Bank Digital Currencies when countries are finally ready to release them. In their white paper (released before their rebranding) they said: “our hope is that as central banks develop central bank digital currencies (CBDCs), these CBDCs could be directly integrated with the Libra network, removing the need for Libra Networks to manage the associated Reserves, thus reducing credit and custody risk. As an example, if a central bank develops a digital representation of the US dollar, euro, or British pound, the Association could replace the applicable single-currency stablecoin with the CBDC.”

But, while watered down, their dream of a digital currency based on a basket of existing currencies and assets isn’t dead. The new digital currency would be formed by aggregating each of their stablecoins in some fixed ratio, and it would only be offered in countries that don’t already have their money represented on Diem’s platform. To further appease governments, they say they “would welcome the oversight and control over the basket composition (both currencies included and their respective weights) by a group of regulators and central banks or an international organization (e.g., IMF) under the guidance of the Association’s main supervisory authority, the Swiss Financial Market Supervisory Authority (FINMA).”

Diem is now hoping to launch in 2021 and, although it’s not as dramatic or ambitious as their original plans, it’s still worth keeping a close eye on.

Stablecoins / CryptoDollars

There was a time when stablecoins were simply a tool used by crypto traders to move funds and escape volatility without leaving the crypto-ecosystem, but they’ve become increasingly important as time has passed. Today, stablecoins are the default trading pair for most cryptoassets, they provide a lifeline for ‘unregulated’ or offshore exchanges that struggle to access the traditional financial system, and they provide a way for people in countries with weak currencies and strong currency controls to access a dollar-like asset.

2020 was the biggest year for stablecoins so far, with their total market cap growing from a little under $6 billion at the start of the year to $28 billion at the end. As you’d expect with that kind of growth in supply, on-chain volumes for stablecoins also exploded in 2020, rising from around a quarter of a trillion dollars in 2019 to more than $1 trillion in 2020.

That incredible growth was driven by a flight to safety after Black Thursday, the rise of stablecoin-collateralised derivates as traders moved away from BitMEX, and the yield farming craze of the DeFi summer.

But, stablecoins aren’t all about crypto trading. Because they bring many of the same benefits as Bitcoin (albeit in a slightly weakened way) and combine that with the assurance of stability, stablecoins can make bottom-up dollarisation in countries suffering economic and monetary crises that much easier.

This year, we got a taste of how impactful stablecoins can be when USDC and AirUSD were used to distribute funds in Venezuela. The funds originally belonged to the Maduro government but were seized by the US in 2019, who released them to the Guaidó government’s account at a US bank. In an effort to get those funds to the people that need them in Venezuela, the Guaidó government used them to mint USDC which were then sent to Airtm, a bank-and-blockchain connected payment platform operating throughout the Americas. Airtm converted the USDC into their own stablecoin, AirUSD, and distributed that to Venezuelan healthcare workers, who could either spend them using Airtm’s virtual debit card, send them to other users, or withdraw them as bolivars at their local bank. The beauty of this system is that the Maduro regime has no way of preventing payments despite their tight control over the traditional financial system, while users only need a mobile phone and an internet connection to send and receive funds.

Obviously, this system isn’t a solution to all of Venezuela’s problems and right now it’s only helping a relatively small number of people, with something like half a million Airtm users in the country, but it’s a start. And, when you see traditional banks like Wells Fargo dropping support for the popular payment service Zelle in Venezuela, the potential of cryptodollars is clear. Venezuela is dollarising: some 64% of transactions in the country already use dollars. Today, most of those payments are physical. In a few years time, it wouldn’t at all be surprising if they were predominantly digital and conducted using stablecoins.

Outside of Venezuela, Circle spent much of 2020 laying the foundations to expand USDC usage outside of the crypto industry. In March they released USDC Business Accounts and APIs that would make it easier for businesses to use and receive USDC. Then, in December, they partnered with Visa to add USDC payment capability into their credit cards.

Meanwhile, JPMorgan finally announced their fiat-redeemable ‘JPM Coin’ was ready for use and created a new blockchain unit called Onyx because blockchain solutions could “become a real business” for the bank, according to their head of wholesale payments. JPM Coin was originally envisaged as a way to enable faster and cheap cross-border payments and is apparently already being used by one large international company. While this isn’t a public-facing service at present, it will be interesting to see how the project evolves. It’ll also be interesting to watch the bank’s efforts around Central Bank Digital Currencies, as they’re reportedly looking to provide payment rails for them.

Unsurprisingly, all the activity around stablecoins has attracted the attention of some rule-makers. In early December, three house Democrats unveiled the STABLE Act, intended to regulate stablecoin issuers. If approved, the bill would essentially force stablecoin issuers to become a bank, massively raising the barrier to entry and therefore reducing innovation. Some broad interpretations of the bill would even require every Ethereum node operator to attain a banking license in order to process stablecoin transactions. Luckily, this bill is unlikely to ever become reality, but it shows that stablecoins are starting to become a truly noteworthy sector of this industry.

A more positive example of the attention stablecoins are receiving was the guidance released by the US Office of the Comptroller of the Currency in September, which opined that federally chartered banks can hold reserve assets for fiat-backed stablecoins. While this may sound like a relatively minor announcement, the guidance provides a degree of certainty for banks unsure of the situation, and that can only be a good thing for stablecoin issuers.

CBDCs

Central Bank Digital Currencies could be one of the most important stories of the next decade, with potentially massive implications on privacy, freedom, and monetary policy. The original announcement of Libra and news of China’s CBDC efforts have acted as catalysts for central banks and governments all over the world to start investigating their own digital money offerings, and 2020 was full of developments on that front.

While the US is far from leading the charge towards CBDCs, they’re clearly considering one. The Federal Reserve made multiple comments about them throughout the year and published a thorough review of existing literature on CBDCs in November, which made it clear there are still many options on the table when it comes to their implementation.

One of the loudest voices calling for a US-launched CBDC is former-CFTC head Christopher Giancarlo (AKA Crypto Dad). In January of last year, he launched a non-profit called the Digital Dollar Foundation to support efforts towards and advocate for a central bank digital currency for the US. The Digital Dollar Foundation released a white paper in June that argued the country needs to start seriously considering how it would implement its digital currency and discussed the key characteristics it should have. And the Foundation also managed to make itself heard at 3 separate congressional hearings, so it seems they may have a real influence on things moving forwards.

Europe seems to be a bit further along in its efforts. Sweden, for example, launched a trial of its e-Krona in February — though they’re only using ‘simulated users’ rather than real ones for now. France launched an experimental program to test a digital Euro in April, while a representative of their central bank said in December that there were more experiments to come and that they could lead to regulatory changes down the line. And, the Swiss Central Bank and the Bank for International Settlements were expected to begin tests with their own digital currency implementation by the end of 2020, paving the way for experiments with a retail-facing CBDC in the future.

The most significant CBDC stories on the continent have come from the European Central Bank (ECB), who formed the Eurosystem High-Level Task Force on CBDCs in January 2020 consisting of representatives from more than 20 European central banks. In October, they released a report on a digital euro that said they needed to be prepared to issue one “should the need arise”, laying out four scenarios that would necessitate the launch of a digital currency, including “a broad take-up of CBDCs issued by foreign central banks”. Later in the year, at the ECB Forum on Central Banking, ECB President Christine Lagarde said a decision on whether to pursue the launch of a digital euro would be made in January of this year, and that her “hunch” was Europe would press ahead with it. If that happens, she added the proper launch of the currency would probably take between two and four years.

We’re also seeing a degree of international cooperation between central banks as they combine efforts in the research phase. In January, the Bank of England formed a group with The Bank of Canada, the Bank of Japan, the European Central Bank, Sweden’s Riksbank, the Swiss National Bank and the Bank for International Settlements to assess potential use cases for CBDCs.

In October, they published a report detailing how digital currencies should be designed. They outlined “foundational principles and core features” of CBDCs, such as stating they must coexist with and complement existing forms of money and be convenient, low cost, and highly available.

Some nations are much further ahead in their efforts to release a CBDC, with a couple of countries actually doing so in 2020.

In October, The Central Bank of the Bahamas officially launched its ‘sand dollar,’ a digital version of the Bahamian dollar that is intended to improve access to regulated payments and financial services for “under-serviced communities and socio-economic groups,” while increasing the efficiency of transactions in the country. At an event shortly before the Sand Dollar’s launch, a representative of the country’s central bank said that while the currency would initially only be used in a domestic setting, they were working to make it interoperable with international currencies.

That same month, Cambodia’s central bank launched its Hyperledger-based payments system that has been described as a “payment backbone” as opposed to a CBDC. Whatever it is, they hope it will combat dollarisation in the country and make it cheaper and easier for migrant workers to send money back home.

By far the biggest and best-known experiments in Central Bank Digital Currencies belong to China, who stepped up their testing efforts in a big way in 2020 as they aim to become the first major nation to release a CBDC. The People’s Bank of China (PBoC) hopes their digital currency, officially known as the Digital Currency Electronic Payment (DC/EP), will help internationalise the yuan and reduce the US dollar’s dominance. They even described digital currencies as a ‘new battlefield’ of competition between nations.

DCEP pilots began in multiple major cities in 2020, with the most famous tests involving tens of thousands of participants who received ‘red packets’ containing about 200 yuan. In November, the PBoC’s governor said these tests had resulted in more than 4 million transactions being made, moving over 2 billion yuan ($300m).

The biggest test began in Suzhou in December, timed to coincide with a major year-end shopping festival called Double 12. The city gave away 20 million yuan via a lottery, again in the form of thousands of red packets worth 200 yuan each. This experiment was bigger than previous ones in every way: there were more participants, more money given away, more stores to spend the DCEP at, more major companies like JD.com and ride-hailing giant Didi taking part, and more major banks supporting a DCEP wallet. It was also the first big test of the currency’s offline payments, though fewer than 1000 of the total 100,000 lottery winners were able to try this feature.

While it seems the country is expecting to continue experiments for some time, China is clearly close to a widespread rollout of the DCEP — Huawei wouldn’t have launched a phone with a built-in DCEP hardware wallet if that wasn’t the case. This is going to be an incredibly important story to watch over the next year or two, as will the response of other government who will likely find themselves under growing pressure to launch competing initiatives.

Disclaimer

Anything expressed here is my own opinion stated for informational and educational purposes; nothing I say should be taken as investment or financial advice. Any projects mentioned are not recommendations and may be highly experimental and therefore risky. Please evaluate your own risk tolerance before trying them out.

I may own some of the cryptoassets mentioned.

At the time of upload (February 2021), I own:

• Long Term Holdings: Bitcoin (BTC), Ether (ETH)
• Short-Medium Term Holdings: Aave (AAVE), Alpha Finance (ALPHA), Terra (LUNA), THORChain (RUNE), SushiSwap (SUSHI), Uniswap (UNI), Nexus Mutual (NXM), Yearn.Finance (YFI)
• Stablecoins: USDC