The Future of Money: Stablecoins & CBDCs
|— The kind of money we use today is called ‘fiat money’—which essentially means it’s not backed by another asset (like gold or wheat).|
— It’s easy to use, widespread, and widely accepted, but is overly centralized, expensive to produce, and can lack privacy.
— To address these issues, two main alternatives are currently being developed: stablecoins and central bank digital currencies (CBDCs)—both of which have their advantages and limitations, and are still somewhat experimental (for now).
Stablecoins and CBDCs are dubbed the future of money. let’s explore.
Money. We all need it and use it regularly—for the most part at least.
But did you know that the concept of money has changed considerably throughout human history?
There have been more than a few paradigm shifts in the way we earn, barter, and spend. And in this time, we have made huge strides in the usability, security, and accessibility of money, making it both safer and faster to use, and more resistant to counterfeiting.
Much of this was enabled by the rapid development of computers and the internet, and recently, the COVID-19 pandemic fueled a further surge in accessibility technologies.
In the 5,000 year long history of money, we’ve gone from using currencies backed by barley (commodity money) to notes and coinage backed by gold (gold-backed money), and finally, to the type of money we use today—fiat and credit (which aren’t backed by anything).
These changes were mostly made to help scale up the economy. As countries experienced dramatic industrial growth, they needed a way to grow their spending without being constrained by resource shortages.
This led to the creation of fiat money that can be created as and when needed.
Right now, most money (around 97%!) exists in the form of bank deposits, which are created when banks provide loans and overdrafts. This money is essentially created out of thin air, since it is just represented by a record on the Bank’s balance sheet—it didn’t exist before the loan was created, yet it can still be spent just like cash.
But we’re not done yet. Though regular cash is easy to use and difficult to counterfeit, it’s not exactly cheap to produce nor efficient to move around. On the other hand, bank deposits are more efficient, but come at the cost of a lack of privacy and an over-reliance on centralized intermediaries like banks, who can block or delay transactions for any reason, or even for no reason at all—making for a frustrating experience in many cases.
You’ve probably experienced some of the issues yourself. Ever had your account blocked for “suspicious activity” that wasn’t actually suspicious at all? That’s centralization for you.
Here, we take a look at these two new technologies, and find out what they mean for you.
As you may be aware, the cryptocurrency market is generally filled with ‘volatile’ digital assets—which means their value can fluctuate considerably over any given time frame.
Although this volatility can be beneficial—e.g. when the price of the cryptocurrency goes up while you’re holding it, this isn’t always how it plays out, unfortunately.
But almost seven years ago, several entrepreneurs worked out a way to create the first price-stable cryptocurrency by simply creating a cryptocurrency that is backed by other assets that are worth at least a fixed amount, like traditional currencies (e.g. USD, GBP, CNY) or commodities (like gold).
They’re a bit like the digital money you might hold in your PayPal or Skrill account—but you’re instead free to store them in your own wallet—without relying on a custodian.
Since these are backed by actual assets (with a few exceptions), they’re able to maintain a roughly stable value. This gave cryptocurrency users a way to opt-out of volatility whenever they choose and unlocked a huge range of new use cases.
Stablecoins are somewhat decentralized and extraordinarily secure—thanks to the blockchain they’re built on. But perhaps more importantly, they also offer users some major advantages over both regular cash and other cryptocurrencies.
For one, they’re more attractive to merchants. This means more stores and service providers are likely to consider accepting stablecoin payments rather than regular cryptocurrencies—since they won’t need to risk potentially losing money due to volatility.
They’re also incredibly quick and inexpensive to use. Right now, you can generally expect a stablecoin transaction to complete in just minutes with an insignificant fee.
Unlike our good old wire transfers.
If you’ve ever tried to send cash abroad, you’d know that it can be incredibly expensive, since the average remittance fee is a whopping 6.5%. This means for every $10,000 you send, you’ll lose a staggering $650 in fees alone!
With stablecoins, this transaction would likely cost you under $10 (depending on the stablecoin you use and a few other factors).
But they’re not perfect.
The main issue is that you generally need to trust that the firm behind the stablecoin is both legitimate and solvent—e.g. that they actually have enough reserves to cover all of the stablecoins that are in circulation.
These issuing firms also often have the power to freeze or block accounts, or blacklist specific addresses, which means they’re not as resistant to censorship as regular cryptocurrencies—and they’re somewhat similar to banks in this respect.
Though they’re still massively cheaper to send abroad than using a remittance firm, the cost is slowly creeping up over time, since the popularity of stablecoins has caused congestion on the Ethereum blockchain. There’s simply too much demand and not enough bandwidth to process all stablecoin transactions quickly and at low cost.
Stablecoins are, in some ways, muscling in on the territory of banks. After all, they move the process of issuing new (crypto)currency to a private firm, and also allow users to directly manage their finances—rather than needing a bank account.
Now you might be thinking “surely it’s the end for banks then”—well, as it turns out, that’s probably not the case.
Instead, a huge number of banks worldwide have begun experimenting with their own take on the stablecoin—known as a central bank digital currency, or CBDC. Overall, according to a 2020 survey carried out by the Bank for International Settlements (BIS), a whopping 80% of banks are now working their own CBDC or researching around them (as of January 2020).
These are pretty similar to stablecoins, in that they’re digital currencies that represent a fiat currency and are based on a blockchain (or something similar), but they have several key advantages and disadvantages.
The main difference is obvious but important—they’re issued and distributed by a bank. This brings with it a great deal of credibility and often security, since banks need to adhere to all sorts of regulations and licensing conditions that keep them in check.
On top of this, CBDCs will also likely have absolute price stability—unlike stablecoins, which can sometimes deviate slightly from their peg for several reasons, including sudden changes in demand and fear, uncertainty, and doubt (FUD).
Compared to real money, CBDCs are arguably faster, easier to use, and most of all cheaper to handle. For you, this means domestic and international transfers might settle in just minutes (not days) and won’t cost an arm and a leg anymore, since blockchain brings dramatically improved efficiency.
They might also lead to better financial inclusion (theoretically at least) since you might not need to create a bank account to hold your CBDC assets. This has potentially massive ramifications for those that either can’t or simply don’t want to open a bank account—i.e. around 1.7 billion adults worldwide!
But despite their clear advantages over cash and stablecoins, they also have their fair share of negatives.
If you’re using cash, cryptocurrencies, or stablecoins for the freedom and privacy they offer. That’s likely to be stripped away with CBDCs—since odds are you’ll need to complete identity and anti-money laundering checks to hold stablecoins.
They’re also likely to be quite the costly endeavor to implement since banks would need to develop the infrastructure behind it, jump through regulatory hoops, and involve themselves more in the settlement process.
Unfortunately, the cost of this would probably be passed on to you and other users, in the form of increased minimum deposits, extra fees, and reduced interest rates.
In any case, you may need to wait quite some time before your local bank begins supporting a CBDC—since they’re still squarely in the developmental stage at the moment.
In the last few years, a huge amount of funding and effort has gone into building a blockchain-based currency that could represent a suitable alternative to paper money and bank deposits.
Stablecoins are currently widely used among cryptocurrency holders, but have yet to reach mainstream acceptance, whereas CBDCs are still experimental and aren’t yet ready for public use.
But with progress happening faster than ever before, it may not be too long before one of these future currencies becomes a regular part of society, and both holding and spending stablecoins and CBDCs becomes the norm.