CBDCs or Stablecoins? There’s space for both
Time to Read: 6 minutes
Central Banks and Private Sector Issuers continue to develop their respective digital currencies, CBDCs and stablecoins. While this could be perceived as a type of competition, realistically both stablecoins and CBDCs could co-exist and provide differentiated benefits.
Digital currencies are on the rise. Private sector stablecoins are being adopted at a fast pace, with a market capitalization now exceeding $181 billion. At the same time, central banks are accelerating their research into Central Bank Digital Currencies (CBDCs) with a few conducting pilots to test nascent distributed ledger technology (DLT) before potentially launching a CBDC to the general public.
Digital currencies, DLT, and evolving payments systems
Digital currencies represent new forms of money, while distributed ledgers can be used as a new form of payment system. Intrinsic to financial infrastructure, payments systems enable the transfer of value between participants, facilitating the flow of funds among individuals and businesses; payments systems are critical for the functioning of economies.
Digital currencies are electronic representations of value on a distributed ledger. Stablecoins are private sector issued digital currencies that use reserve assets, such as the US Dollar, to maintain a stable value. CBDC, on the other hand, is issued by the Central Bank and can be considered a digital form of cash. DLT is a technological infrastructure that holds the records of value and transactions of digital currencies: as such, digital currencies sit outside the current financial infrastructure based on traditional accounts.
Developments in digital currencies and DLTs present opportunities to modernize the financial system, not just challenge it. Yet, as these innovations materialize and are adopted, an important question arises about whether the public or private sector should manage the issuance of digital currencies and implementation of new payments systems. Conceivably, both sectors could contribute unique value in DLT-based money and payments systems.
The public sector and financial stability
The public sector plays a critical role in the provision of money and payment systems. Central banks are charged with ensuring trust in money and efficient payments as core public goods. Trust in a currency relies on price stability and wide acceptance of the currency as legal tender. This stability is essential for smooth functioning of the economy.
The private sector is a key contributor to financial infrastructure
Private sector financial institutions and payments system operators play a different but vital role in payments systems. Payments are at the center of economic activity, and thus having multiple payment networks – instances of a specific payment system – supporting economic activity reduces systemic risk. Private sector-led payment systems diversify critical financial infrastructure.
Additionally, the private sector, as a provider of important financial services to businesses and individuals, is a key source of continuous innovation in the financial industry.
Diversifying money issuance and payment systems
With these distinct roles, both public sector CBDCs and private sector stablecoins built on DLT could modernize payments infrastructure, better serve consumers, and provide new benefits to an increasingly digital economy.
The benefits of a Central Bank Digital Currency (CBDC)
A Central Bank issued CBDC would provide a digital public payment option to meet the evolving needs of the digital economy. As a liability of the central bank, the CBDC would continue to ensure trust in money by being a digital means of payment available to the general public and, in a stable economy, one that is considered risk-free.
Digital currencies support new types of payments. Micropayments – payments that are relatively small in value, usually less than $1 – are useful in the digital economy. For example, digital content providers may structure their business model to charge such small amounts for access to their content. While micropayments are typically uneconomical to process in legacy payment systems, digital currencies could provide a more viable solution. With no profit motivation, the central bank could provide a payment service using CBDC to the public at a lower cost, thereby promoting efficient payments in the digital economy.
The benefits of stablecoins issued in concert with CBDCs
Private sector issued stablecoins on DLT would offer an alternative means of payment for the digital economy, increasing the resilience of national payments infrastructure with the presence of multiple DLT-based payment networks.
Additionally, as providers of important financial products, such as lending, saving and insurance, the private sector could utilize emerging technologies like DLT and smart contracts to create new products and services, potentially developing ways to better serve households and businesses. For example, using smart contracts, financial institutions could issue programmed money which includes code that automatically executes a transaction once predetermined conditions are met. The use cases of programmable money continue to be developed amidst the ongoing innovations of digital currencies and distributed ledger systems.
Finally, digital currencies could improve cross-border payments. Central banks are exploring ways to solve cross-border payment challenges with CBDC, but providing foreign entities the ability to hold a sovereign digital currency raises important non-technical issues, such as national security concerns and questions around data privacy. Coupled with the application of new technology to sovereign currencies and payments systems, resolving these issues may take time and would likely require significant collaboration between governments.
Private sector stablecoins may provide an expedited solution. Stablecoins currently sit outside national account-based money and payments systems; as such, they could accelerate the streamlining of cross-border payments. By exchanging fiat currency for a tokenized value, stablecoins move outside of correspondent banking networks, potentially offering meaningful improvements to cross-border payments.
While private sector issuance of stablecoins can be beneficial, there are inherent risks involved such as concerns around monetary policy, use of consumer data, and bank runs or disintermediation. Appropriate regulation of money issuers and oversight of payment system providers is necessary to protect consumers and ensure financial stability. Globally, governments are implementing regulation over these activities, each with differing approaches. President Biden’s recent Executive Order on digital assets has laid a rigorous roadmap for addressing digital currency issues, indicating that regulation and/or legislation in the U.S. is imminent.
Both the private and public sectors play pivotal roles in the delivery of money and payment systems to the public. The private sector drives innovation and the creation of new products and services along with diversifying critical payments infrastructure while the public sector safeguards trust in money and works to ensure financial stability. A modern financial system that includes both CBDCs and stablecoins on DLTs could enable a public digital payment option useful in the digital economy, accelerate the streamlining of cross-border payments, and support the creation of new products and services that better meet the evolving needs of consumers and businesses.
About the Author. As a Global Senior Associate at Glenbrook, Bethany brings experience in economic and policy research, consulting, financial services and international development. With her focus on both business and public issues, Bethany is deeply interested in the future of finance and the evolution of digital finance for an inclusive financial system and economic growth.