Stablecoins and CBDCs: Navigating the New Era of Digital Finance

Published On: Feb 1, 2024By
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In the rapidly changing world of digital finance, evolution is inevitable. Stablecoins and Central Bank Digital Currencies (CBDCs) are emerging as two similar digital currency technology formats but with distinctly different purposes.

As we delve into the intricacies, however, it becomes evident that both are redefining the landscape of monetary transactions and financial systems globally.

Introduction

Stablecoins remain rooted in the cryptocurrency ethos, they offer price stability by being pegged to traditional assets like fiat currencies or commodities. Stablecoins come in a variety of forms including 1-for-1 fiat collateralized stablecoins, asset-backed stablecoins, crypto-backed stablecoins, and algorithmic stablecoins.

Meanwhile, CBDCs represent nation-states in digitizing their national currencies.

This article aims to unravel the complexities, utilities, and transformative potential of these digital asset formats, and offer an understanding of their respective roles in modern finance.

This post was published by the Stabull Finance insights team. Stabull Finance is a Web3 capital-efficient Automated Market Maker-based swap facility for Stablecoins — Fiat and other tokenized assets. It is designed to facilitate the democratization and decentralization of the multi-trillion dollar FX and commodities markets on-chain.

Stablecoins have revolutionized the crypto sector

Stablecoins are undeniably one of the most successful technology paradigms ever built within crypto. Stablecoins are a form of cryptocurrency and digitized real-world assets (RWA) designed to offer price stability. They are typically pegged to a stable asset, fiat currencies, like the US dollar, or commodities, like gold. Digitizing these assets boosts their utility and allows them to be used within blockchain-based decentralized applications.

One of the most popular forms of the stablecoin model is the tokenized version of a national currency. Digitized versions of the US Dollar, Euro, Japanese Yen, Australian Dollar, and British pound. The total market cap of the USD stablecoin ecosystem hovers around the US$150 billion mark. They are popular tools for traders needing protection from volatility, users seeking an alternative to fiat for tax purposes, a digital cash alternative, or a stable asset to earn yield from with the DeFi ecosystem.

Stablecoins and CBDCs are distinctly different

The dominant position stablecoins hold within the Digital asset ecosystem may be challenged by the emergence of Central Bank Digital Currencies (CBDCs). A CBDC is a form of digital currency issued by a nation-state’s Central Bank. CBDC is a new form of fiat legal tender, a government-issued currency that has no backing from a physical asset like gold or silver. In most cases, they are issued as banknotes or coins. Empowered by blockchain, however, several Central Banks are exploring CBDC options — national currencies that operate on a credit-based model that records balances and transactions digitally.

While there are clear similarities between CBDCS and Stablecoins, they are both assets that mirror the price of fiat currencies. Both can also transform the functionality and portability of fiat currencies.

In our view, however, there are clear distinct differences between the utility and appeal of stablecoins and CBDCs.

CBDCs are issued by central banks, while stablecoins are issued by private entities. There are clear regulatory challenges that stablecoins have to solve. Additionally, they need to be commercially viable and stablecoin issuers like Tether and Circle have employees they need to pay.

Stablecoins also require a pegging mechanism, and back-end operations that allow their tokens to hold their value. Physical assets are needed to support the value of Stablecoins; generally 1-for-1 equivalent assets. CBDCs derive value by decree and need no such backing mechanisms, likely making them more reliable than stablecoins, at least from a regulatory standpoint.

Stablecoins are far more private than CBDCs. Despite transaction information on blockchains being published openly, and being viewable on block explorers, this is very different from CBDCs where the government is in control of transactions and can demand information from transactors whenever they want. While some issuers and exchanges utilizing stablecoins are subject to reporting requirements, they still operate at an arm’s length from the banking and fiat system, much like other crypto assets. CBDCs are state-issued and most will likely have in-built surveillance and government control.

Many observers have suggested that CBDCs represent a dystopian tool for governments to confiscate and redistribute wealth more precisely. CBDCs for example, may be programmed for use only within a specific geographical area, thus allowing a government to enforce lockdown restrictions more strictly. Many suggest CBDCs can be extended to form the basis for a social credit system, with punishments and rewards for different spending habits.

Stablecoins are also different in their reach and purpose. A leading use case for stablecoin is as a tool to access Decentralized Finance solutions. Stablecoins like USDC and USDT can be deposited on platforms like Curve and Compound in exchange for a yield. This means for many holders, stablecoins are an avenue to build the equivalent of a foreign bank account (store of value).

The USD, Euro, or British pound stablecoins are pegged to their fiat equivalents, representing dominant international currencies. The yield earned by acting as a liquidity provider acts as the interest rate. For citizens in developing, particularly those with inflating local currencies, countries like Lebanon and Argentina, stablecoins are escape hatches from devaluing wages and expensive remittance systems.

The potential of stablecoins is only being scratched. Alongside its ability to be a traditional banking substitute, stablecoins can conceivably disrupt FX markets. The decentralization of Forex markets through blockchain technology and the strategic use of stablecoins represents a potential transformative shift in global financial systems.

Conclusion

The emergence of Stablecoins and CBDCs represents profound shifts occurring in the financial sector. Stablecoins have established themselves as pillars within the cryptocurrency market, offering stability, privacy, and a bridge to decentralized finance. CBDCs, are issued by and rely on the trust of central banks, promise a future of enhanced financial policies, greater control, and possibly a reshaping of monetary governance.

While they share the commonality in that they both involve digitizing fiat currencies, their distinct origins, regulatory frameworks, and implications for privacy and financial control set them apart. They both have space in the world and Stablecoins will likely have to be backed by CBDCs in the future.

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