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From Stablecoins To Central Bank Digital Currencies

Blockchain technology has paved the way to many innovations, in different sectors, among which we can find the public financial sector. The world is witnessing the decentralized creation of currencies but also of commodities and polished digital goods and services, as blockchains meld technology and the markets to build Web 3.0.

In the last few years there has been a fast growth of Stablecoins, which are cryptocurrency that is collateralized to the value of an underlying asset and can be thus used for everyday means of exchange, as store of value, market entry, solving the volatility issue that arguably holds back the potential adoption of cryptocurrencies for everyday payment purposes. Stablecoins are guaranteed by fiat currency, and can be convert to cash or bank deposits granted by law at par. The central bank (CB) plays the role of lender of last resort, while private commercial banks regulate issuance to individuals and might set interest rates similar to traditional bank deposits. There are three typologies of stablecoins. The first are asset-backed off-chain stablecoins, meaning that they are backed by a regular fiat currency, precious metals, or other real-world assets; this typology requires trust in a centralized third party to hold the collateral. Secondly, there are asset-backed on-chain stablecoins, which are backed by cryptocurrencies and their volatility depends on the stability of the cryptocurrency. Lastly, algorithmic stablecoins rely on a combination of algorithms and smart contracts to maintain price equilibrium. Stablecoins bear the benefits of cryptos; they include lower-cost and safer real-time payments compared, offering low fees and secure transaction. Although stablecoins seem to be a safe innovation, their disadvantages of also needs to be considered. Stablecoins require a third trustworthy party, departing form the DLT(Distributed Ledger Technology) on which cryptos are based on. Moreover, there would be less return on investments, turning into a less attractive source of revenue for investors and traders.

Nonetheless, stablecoins represent a form of private money and central banks, therefore, have begun exploring possible forms of digital public money, landing on CBDC, central bank digital currency. Several central banks are currently issuing their own trials and research projects, even though most are at the early stages. Among these, we can find the Central Bank of the Republic of China, the Bank of Japan, the Sveriges Riksbank (Sweden), the Bank of England, the European Central Bank, the National Bank of Ukraine. The technology behind CBDCs depends on the preferences of the national bank; the common trend is to run CBDCs on distributed ledger technology on which the transaction history can be recorded and data become immutable, as well as ensuring privacy and security.

Central bank digital currency can represent a cash-like commodity in a peer-to-peer network, offering cross-border payments and accessibility. The latter characteristic depends on the design choice of the central bank, which could issue either a retail or wholesale CBDC. Retail digital currencies can be conceived as a digital extension of cash that can be used in everyday transactions by individuals and households. On the other hand, wholesale CBDCs are used by financial institutions for interbank operations. There are three possible architectures for issuing the retail CBDC: indirect, direct and hybrid. In an indirect architecture, intermediaries handle retail payments and central banks handle wholesale payments. Direct CBDC: no intermediaries, the consumer claims to the CB, which handles all payments in real time. The direct architecture eliminates dependence on intermediaries but raises the issue of scalability and speed of operations. From a security perspective, the central bank might represent a central point of failure. Lastly, the hybrid CBDCs displays a system in which direct claims are done directly to the central bank and real time claims are managed by intermediaries. In all three architectures, the central bank is the only party that can issue and redeem the currency.

In conclusion, from the brief description above, it is possible to infer that stablecoin and CBDCs can be similar in some ways but are also different. Both digital assets perform functions associated with fiat money; nonetheless, only one typology of stablecoin is backed by fiat currency, while CBDCs on blockchain are always pegged to a country’s currency. Moreover, stablecoins back by fiat currencies, such as Tether and DIEM can be issued by either unregulated entities or regulated entities (commercial banks). On the other hand, CBDCs would be issued by central banks only to commercial banks, which in turn would distribute them to customers.

Giovanna Alberta Stefani

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