Cutting Through the FUD Part IV — The Threat of Central Bank Digital Currencies
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Facebook has kicked the hornet’s nest with its Libra project. This has triggered a global debate over the digitization of national currencies, so much so that some have dubbed 2020 the year of the central bank digital currencies.
Many in the crypto community are concerned that these government-backed centralized digital currencies will undermine BTC and other “real” cryptocurrencies. I believe this is not a zero-sum game as more activity and competition can generate greater mindshare and adoption.
The times are changing. In the past few years, central bankers would regularly denounce or deride privately issued digital currencies and stable coins. All that changed when Facebook announced its Libra cryptocurrency initiative earlier this year. For the first time, governments and central bankers around the world are waking up to the threat as well as promise of digital currencies and assets. The next few years will define how they engage with this new asset class. There is no winding back the clock.
The International Monetary Fund (IMF) and its former Chair Christine Lagarde were among the earliest to advocate the benefits of digital currencies. Lagarde recognized that the world of fiat money is in flux, and innovation will transform the landscape of banking and money. She has further stressed the need for these digital currencies to have interoperability across blockchains, as well as interoperability between fiat cash and digital currencies, and between centralized and decentralized systems. This proposal is far-sighted on the IMF’s part.
Such a system would effectively pit private money against government issued money, giving choice to end users. This will check the power of governments and central banks and put the onus on them to ensure that they pursue sound monetary policy or risk being disintermediated.
Other global institutions are starting to sing the same tune. In an article published on Nov. 26, the World Economic Forum highlighted the true value that digital currencies such as stablecoins could have on creating a fairer and more inclusive global financial system.
Digital currencies offer benefits such as low costs, global reach, and speed. Moreover, they can be embedded into digital applications thanks to their open architecture, as opposed to the proprietary legacy systems of banks. However, in my view, the biggest attraction comes from the networks that promise to make transacting as easy as using social media, enabled by the enormous user bases of large technology firms such as Facebook and Telegram.
Among digital assets, stablecoins are best positioned to be widely adopted as a means of payment, notwithstanding the passionate stance of BTC, BCH, BSV and LTC believers. Merchants need a price stable asset as a medium of exchange. To-date there are over 200 stablecoins operating across a number of different blockchains and protocols. Private organizations have led the way in launching stablecoins with USD-backed coins like USD Tether, USDCoin, TrueUSD and USD PAX the most active.
Some governments are catching up. China’s central bank (PBOC) was among the first central banks to grasp the impact of digital currencies, exploring its potential as early as four years ago. It will likely be the first major nation to launch its own central bank-backed digital currency (DCEP) in a few months. The DCEP will likely target retail payments first according to the PBOC but will also extend to cross border finance in future.
Reacting to the China threat, governments around the world are drawing up plans to digitize their own national currencies. In Jan 2019, the United Arab Emirates’ central bank (UAECB) and the Saudi Arabian Monetary Authority (SAMA) jointly announced that the interbank digital currency they are co-developing will be called “Aber.” “Aber” will not be available for retail usage. Instead, its use will be restricted to facilitating interbank financial settlements.
The Association of German Banks, a lobby group of more than 200 private commercial banks, recently called for a “programmable” digital Euro and a common pan-European payments platform, citing competitive pressures from the US and China. The ECB is currently exploring the regulation of digital assets and the issuance of its own digital currency.
While former CFTC Chair Christopher Giancarlo (a.k.a. Crypto Dad”) said he plans to advocate for the development of a digital dollar, it is safe to assume the US will likely be a late (if not last) mover in this race as it will seek to maintain the hegemony of the USD. Many of the existing private stablecoins (including Libra) are currently either pegged to the USD or have a dominant weighting in USD, hence this will preserve the USD’s dominance in the near term. This will keep the US Federal Reserve complacent at least for a period of time. Treasury Secretary Mnuchin along with Fed Reserve Chair Powell stated that there is “no need for the Fed to issue a digital currency” for at least the next five years.
While central bank stablecoins are the antithesis of the decentralization ethos of cryptocurrencies, they will accelerate mainstream adoption of digital currencies and assets, benefiting the industry overall. In addition, a plethora of stablecoins also give consumers choice.
Countries with high inflation and weak institutions will face the biggest threat as their local currencies might be shunned in favor of stablecoins in foreign currency. This might undermine monetary policy, financial development, and economic growth. As countries are forced to improve their monetary and fiscal policies, they will have to decide whether to restrict foreign-currency stablecoins.
Existing crypto assets that aim primarily to be mediums of exchange will face severe competition from the likes of Libra and DCEP. Existing stablecoins such as USDT, USDC, and Dai, will also face more competition but they may be insulated due to existing use cases. E-commerce focused TerraUSD and mobile-first Celo Dollar would compete head on with Facebook’s Libra token assuming it gets launched. The Libra association continues to plow ahead in spite of the current regulatory headwinds.
BTC should be a net beneficiary of this as its store of value use case strengthens. If the process of swapping between stablecoins and BTC is close to frictionless, people might even prefer to keep more of their net worth in BTC rather than to hold a stable price asset.
Will central bank digital currencies make the crypto ecosystem more centralized? Yes, of course. That’s why we have an incentive to ensure the survival and success of major decentralized cryptoassets (eg. BTC, ETH and others) and stablecoins such as Dai, Terra and Celo.