January 27, 2022 - 9 min read
2021 was a banner year for interest in stablecoins—digital assets which maintain a pegged value relative to a national currency—has skyrocketed. The market cap of stablecoins grew from roughly $30 billion to approximately $165 billion in just a single year, clocking over 500% gains.
In response to the proliferation of private stablecoins to choose from, the U.S. Department of Treasury released a report detailing the need to enact legislation to prevent “runs” on stablecoins and manage “systemic risks” in the absence of regulatory oversight. Indeed, central banks and nation-states around the world have taken notice and begun development on their own digital currencies (CBDCs) in response.
These CBDCs will essentially be the same as the physical paper currently being issued, but tracked and regulated on a blockchain’s ledger. Over 80 countries have already begun the development of their own CBDCs; the only questions remaining are: who will be the first to deploy, and what the ramifications might be once they begin disrupting legacy systems. Certainly, new laws and regulations are being feverishly developed across the world.
As mentioned, there are already thousands of digital currencies in existence, some more decentralized than others, but they are unlikely to be adopted by sovereign nations as they lack the centrality that central banks are used to exerting over the monetary system. Central control over the money supply is not something that political leaders will take lightly, with many in active competition to be the first to deploy such technologies.
Take the United States, for example, which monitors and regulates nearly all cross-border payments through the SWIFT system. A decentralized system would potentially nullify any ability to prevent money-laundering, fraud, or other criminal activity without the centralized power to do so. Therefore, a global push for highly centralized CBDCs should be expected from politicians and policymakers.
Many central banks are already exploring or even implementing some sort of blockchain technology to underpin the issuance of legal tender in their jurisdictions. Central banks around the world are likely to implement bespoke protocols or else choose firms that suit the larger fiscal goals of the nation, its policymakers, or their citizenry. Of course, each nation will consider things like national security, data privacy, local market requirements, regulatory compliance, and other nation-specific priorities.
Consequently, the need for interoperability amongst these various blockchains will be of paramount importance in order to secure cross-border financial transactions and for merchants to feel comfortable accepting crypto assets at points of sale. Soon, cross-border and cross-chain transactions will essentially mean the same thing.
The Bahamas has already officially launched their CBDC, the Sand Dollar. Sweden’s eKrona may soon follow. After these examples, another notable leader in the development of CBDCs is, of course, China. The People’s Bank of China (PBoC) developed a pilot version of their digital yuan, made available to download on mobile app stores for authorized users in Shanghai.
China has been a frontrunner in terms of developing and deploying their own digital currency, and even claimed it could be used during the 2022 Winter Olympics in Beijing. Ubiquitously used Chinese payments app, WeChat, announced plans to allow users to transact with the digital yuan, increasing the likelihood of adoption.
Of course, Chinese regulators have also banned cryptocurrency mining and transactions, creating a chilling effect on private blockchain firms domestically. Mexico has also recently announced plans to implement their own CBDC by 2024. This puts the nation in company with a large number of nations like Brazil, Uruguay, South Korea, Kazakhstan, Russia, and Peru as confirmed to be working on their central bank’s financial infrastructure overhaul.
Moreover, the Bank of Jamaica (BoJ) has already finished its CBC pilot program and is planning a nationwide rollout in 2022. Irish Cryptography firm eCurrency Mint was chosen as the provider for the pilot program in which 230 million JMD ($1.5m USD) were minted for issuance to payment-service providers.
For instance, National Commercial Bank (NCB) was issued 5 million JMD, which became the first digital wallet provider of the pilot program. Only select customers participated, including 4 merchants and 53 consumers. Following their pilot program, the BoJ intends to add new wallet providers, expanding the use of their CBDC to a wider consumer base, and a focus on interoperability among wallet providers.
The use of cash is slowly being phased out across the world and for a variety of reasons. Increasingly, people are opting to pay for goods and services through some form of electronic payment, whether it be as simple as debit cards or mobile pay apps using QR codes. Take Sweden, for instance, which reported cash transactions dropping from 40% to roughly 10% from 2010 to 2020.
Even in remote and sometimes underdeveloped locations, it’s still possible to go through one’s daily life without touching cash for weeks or even months at a time. This is a trend which will continue for some time to come as CBDCs and other crypto assets are rolled out and adopted by larger user bases.
At present, cryptocurrencies are not a part of most people’s financial lives, though that is likely to change soon for many parts of the world. In the near future, ownership of digital currencies and use of their associated infrastructure may soon be as ubiquitous as owning a mobile phone and connecting to Wi-Fi.
CBDCs will likely be used by financial institutions at first, then offered to merchants, and finally to consumers. Realistically, once CBDC’s interoperability and user experience has been streamlined, there will be no stopping their deployments en masse, many of which are already underway in certain jurisdictions.
Central banks have several clear incentives to replace cash with their own digital currencies: logistics, tracking, and fraud detection. For example, ceasing to print, distribute and store cash and coinage saves on resources and troublesome logistical overheads. The problem of counterfeit dollars being spent in small businesses could be more or less eliminated if each dollar were tracked on a secure, digital ledger.
Another incentive for governments to adopt CBDCs is taxation and refund distribution. Authorities could collect taxes and distribute refunds or other payments (like stimulus) more efficiently and with greater precision. Under-reported income or outright fraud may be nearly eliminated by an immutable record of all transactions stored on the central bank’s blockchain ledger. Essentially, it will make it much easier for tax authorities to see who owes what if tracking software detects tax fraud or money-laundering activity.
One major advantage associated with peer-to-peer payment networks, like blockchains, is that value can be transferred quickly and immediately at the point of sale or transfer. The consumer does not need to wait for the transfer to clear first before being credited to the receiver’s wallet. Consumers will not tolerate more than a moment’s delay for payments to be processed, or else meaningful adoption will not occur.
Non-traditional banks and other private stablecoin issuers are already providing such experiences, prompting early adopters to shift capital away from traditional banks and towards these alternatives. For central banks, a wide variety of offerings would make data collection and monetary policy implementation into greater challenges for a number of reasons, with interoperability and compliance being arguably the most significant.
With regards to interoperability, CBDCs must be interoperable if they are to scale to any significant size. That means that cross-border settlements need to be frictionless and transparent. This is one of the many areas in which data oracles will find themselves needed, as oracles facilitate interoperability by fetching and validating data for smart contracts. Of course, oracles make blockchains interoperable with real-world data, but they can also serve as guardians of data as it passes from chain to chain.
Nevertheless, a world of fully interoperable CBDCs may not be as easy as it seems. Many nations adhere to strict national security compliance regulations, meaning information sharing regarding currency issuance or other sensitive data will not be tolerated.
As for compliance, central banks and regulators will likely counter competition from private stablecoin issuers that currently operate with little oversight. Most likely, private stablecoin issuers (non-CBDCs) will be required to offer equivalent protections currently available to traditional bank deposits.
For instance, Coinbase issues USDC by holding fiat dollars to back the USD tokens at a 1:1 ratio. The implication from global regulators, thus far, is that private issuers—with fiduciary obligations to protect their investors—will not have the incentive or capacity to serve as sources of strength comparable to that provided by sovereign, central banks or their deposit insurers.
Moreover, while distributed ledger technology safeguards against malicious network behaviors and protects consumers’ deposits, national currency CBDCs will face challenges from their own populace if they are to be successfully deployed. Personal data and other consumer KYC information will need to be protected, since the firms collecting and hosting all of this data have political influence whereas private issuers likely do not.
For example, issues regarding anonymity and data privacy are still hotly debated as creating dangerous centralization of power and influence, creating potential conflicts of interest at high levels of government, and other political or social risks.
While comprehensive regulation would protect consumers and facilitate broader stablecoin adoption, it is unlikely that governments will adopt any universal standard in the short term. Consequently, it may be prudent for nations to adopt a collaborative approach between the central banks and private issuers of stablecoins while the development of industry-wide standards and best practices is underway.
After all, innovations in DeFi and stablecoins have placed regulators in an awkward position of trying to protect consumers, financial and political stability, and implement sound fiscal policy, all the while using laws passed before the technology had entered the public’s consciousness.
Until CBDCs have become well established, a standard set of best practices will provide compliance guidelines to stablecoin issuers so that they may protect depositor funds in the event of liquidity crunches, reserve asset price crashes, or other cybersecurity breaches. Private stablecoin issuers can then work with regulators and their consumers to demonstrate that they meet or exceed industry-best practices, in order to mitigate the fear of the unknown and give regulators time to debate the nuances of such regulations.
This transparency should serve private stablecoin issuers well, as anything less might invite the ire of lawmakers and provide enough public support for harsh actions against the space as a whole. Therefore, maintaining good faith between central banks, regulators, and private stablecoin issuers is good for the overall crypto market so long as it lasts.
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