Hi all,

Stablecoins have been frequently mentioned as a major use case in the world of blockchains and cryptocurrencies. They are, in the words of Kory Hoang, 'faster, cheaper, transparent, borderless and programmable'. Sounds perfect for everyday usage when they are also backed up by a central bank, right?

So what’s up?

Most popular stablecoins are currently issued by private companies. That's fine when they are regulated but we all know that regulation isn't always perfect. 

(Such failures can have serious ripple effects although that's a separate discussion. We'll dive into the details in another post.)

Central banks are now catching up. Many of them are discussing the introduction of a so-called CBDC – a Central Bank Digital Currency. Here, we're looking at:

• Stablecoins vs. 'tokenised deposits' (a fancy term for CBDCs)

• Do they compete or coexist?

Let’s get started! 🤓

The Bank for International Settlements (BIS) has published quite a lot of papers discussing CBDCs. Most of them are highly technical as the target group is pretty niche and tends to have a macro-economic background.

At the same time, money issued by a central bank affects all of us. That's one of the vital differences between a CBDC and stablecoins. The latter may offer a lot of benefits but it's completely voluntary to use them. (Admittedly, CBDCs will hardly be compulsory from the outset but this may certainly change over time.)

Given the importance of currencies that are backed by a central bank, it makes sense to look into at least one BIS publication in depth. Let's take, for example, the "BIS Bulletin No 73", published in April 2023. The title already suggests that it's not exactly light reading: "Stablecoins versus tokenised deposits: implications for the singleness of money."

What’s in the paper?

This particular report delves into the world of CBDCs and their potential impact on the financial landscape. If you're not familiar with cryptocurrency concepts, here's a broad summary.

The authors provide useful insights into the evolving landscape of digital currencies in general. CBDCs are part of this group. They are digital forms of a national currency which is issued by the respective central bank. Unlike cryptocurrencies like Bitcoin, CBDCs are centralized and government-backed. In short, they represent traditional fiat currencies in a digital format.

Why would central banks want to issue digital money? There are actually lots of potential reasons. That's why central banks around the world have different motivations for exploring CBDCs.

Two examples? CBDCs could make financial transactions more efficient and reduce costs. They could also help to increase financial inclusion for certain parts of society by providing access to financial services.

Different motivations are one thing. In addition, central banks may also have individual approaches. Both aspects are subject to political influence (which is not actually discussed in the BIS paper). Some institutions focus on improving cross-border payments, others prioritise the domestic financial system.

Key challenges

 For readers who are new to crypto, the authors outline critical considerations and challenges associated with CBDCs. These include:

• a balance between privacy and regulatory requirements;

• potential disruptions to the existing financial ecosystem;

• cybersecurity resilience.

It's hard to overstate how vital the first aspect is. Central banks in particular and politicians in general must balance innovation and stability. Unsurprisingly, the BIS paper highlights careful planning, collaboration with various stakeholders and international cooperation to address challenges associated with the implementation of CBDC.

They also have a very positive view on CBDCs as an avenue for central banks to advance financial inclusion and foster digital innovation. CBDCs could provide secure and accessible digital payment solutions and bring more people into the formal financial system, reducing reliance on cash.

As with every complex project, there are pros and cons. Even the BIS itself underscores the potential impact of CBDCs on the broader financial system. The paper mentions potential implications on monetary policy and financial stability. Another point to consider is the role of commercial banks in a CBDC-driven financial landscape. Why would you still need your bank as an intermediary when you can access financial services directly?

One aspect, however, is missing from the discussion: privacy concerns. Many financial transactions are already digital and can therefore be traced – by banks, law enforcement or other government agencies. Cash may often be inconvenient but it is a potential choice.

Technically, any CBDC can be turned into a comprehensive surveillance instrument, making all financial transactions for every citizen completely transparent. That may not be the ultimate aim for many current governments. Nevertheless, it opens the door to an Orwellian surveillance state in the future.

The broader picture

In the final paragraph, the BIS authors conclude that there may be use cases for stablecoins and other 'tokenised mones' yet they seem 'very much like a step backwards'. Hardly a glowing recommendation for stablecoins (or any other digital asset).

CBDCs are presented as a virtually perfect solution. According to the authors, they provide a valuable foundation for the evolving role of central banks in general in the era of digital money.

All of that shouldn't come as a massive surprise, considering that the BIS's mission is 'to support central banks' pursuit of monetary and financial stability through international cooperation, and to act as a bank for central banks'. The BIS is actually owned by central banks, they are therefore unlikely to come up with a highly critical view of CBDCs in practice.

That's not to say that CBDCs should not exist at all. There are good reasons to discuss them, including the question of whether they should be blockchain-based or not. At the same time, CBDCs and stablecoins could definitely coexist. We'll be looking more into this topic in future articles. After all, money is something that is relevant for everybody.

That’s the end for today! 😢