Understanding Digital Currencies - CBDCs, Stablecoins & Crypto

What is a CBDC (Central Bank Digital Currency)?

CBDCs have become a hot topic within the financial space recently. Governments, banks and institutions alike have been deep in research and analysis on how feasible creating a new form of digital currency would be for the current state of the economy. Much of this research focuses heavily on the impact CBDCs could have on the policies that currently govern the way we value and use our monies.

To simply put it, CBDCs would be a banknote that is used in the same way and at the same value as physical banknotes... just digitally.

A recent survey of central banks found that 86% are actively researching the potential for CBDCs, 60% are experimenting with the technology and 14% are deploying pilot projects so it is evident that adoption is underway.

Still, many tend to confuse the concept of CBDCs with other digital currencies such as stable coins and cryptocurrencies but they all have very definitive features and permissions which is what we'll look into today.

CBDCs explained

A CBDC offers three main elements:

• Is a digital currency

• Is issued by the central bank

• Is universally accessible

• As a centralised form of currency, transactions aren't anonymised like cryptocurrencies are

CBDCs use the same underlying distributed ledger technology of cryptocurrencies (which is the same as Blockchain). The main difference being that governments recognise CBDCs as legal tender within the issuing central bank's jurisdiction. This means that anyone can use them for payments and every merchant must also accept them.

CBDCs and fiat currencies are also considered to be extremely similar so what would the need be for CBDCs? The backing of a central bank increases the safety and efficiency of both wholesale and retail payments infrastructures. On the wholesale side, a CBDC can facilitate quick settlement of retail payments and improve the efficiency of making payments at point of sale (POS) or between two parties (p2p).

If a country decides to contend in becoming a cashless society, issuing a CBDC would give governments an edge over the competition from private e-money as monies would be exchanged in a digital format. As the market for private e-money is on the rise, the pressure for governments to adopt a CBDC is strong although if it does become mainstream, it may put beneficiaries at a disadvantage because e-money providers mainly aim to maximise their profits instead of the general public's.

What is a Stablecoin?

A stablecoin is a type of cryptocurrency that relies on a more stable asset as a basis for its value. People tend to refer to stablecoins as linked to a fiat currency, for example the U.S. dollar, but they can also have value linked to valuable metals like Gold or other cryptocurrencies. Two of the most popular stablecoins to date are Tether (USDT) and USD Coin (USDC), who both claim to be backed by an equal dollar amount of assets.

Stablecoins explained

Stablecoins have been designed in a way that seeks to combat the volatility seen across conventional crypto markets, by fixing their value to a fiat currency or a valuable asset. As long as the value of that currency or asset remains stable, so will the value of that stablecoin.

There are currently 3 categories of stablecoins:

• Fiat-Collaterised Coins

Most stablecoins fall under this category in that their value is backed by a fiat currency or a physical commodity such as oil or metals.

• Crypto-Collaterised Coins

Similarly, these stablecoins are self-explanatory: their value is backed by other cryptocurrencies. What happens here is the reserve cryptocurrency is usually prone to high volatility, so in effect, the stablecoin is over-collaterised. This means a larger number of the cryptocurrency's tokens is maintained as a reserve for issuing a lower number of stablecoins.

• Algorithmic Coins

Lastly, algorithmic stablecoins use computer programs to remain stable. For example, the value of a stablecoin could be pegged to the value of a US dollar but this would be written into the stablecoin's code to track the value of the dollar and adjust its value according to the current exchange rate autonomously.

What is a Cryptocurrency?

A cryptocurrency is a digital or virtual currency that is secured by cryptography, which is the art of writing or solving codes. This unique nature to cryptos makes it nearly impossible to counterfeit or double-spend.

Cryptocurrencies explained

Cryptocurrencies are decentralised digital currencies, whereas CBDCs are centralised, meaning they are governed by a single authority; a central bank. As we know them, cryptocurrencies are extremely volatile and with the lack of government backing, can easily be susceptible to financial cybercrimes.

This kind of short-term volatility makes Bitcoin and the like of other popular cryptocurrencies unsuitable for everyday use by the public. Generally, a currency should be able to be used as a medium of monetary exchange or a mode of storage of monetary value with its value remaining relatively stable over long periods of time. Once you're not sure of what a currency's purchasing power will be tomorrow, you're more likely to refrain from adopting it, hence the lack of government backing.

With all this said, the main appeal of cryptocurrencies is also its main repellant. For those that are more clued up on the behaviours of the crypto markets are more willing to invest into its volatility which is how we've seen millionaires and billionaires being made overnight. When you're able to buy in low, sometimes the value can spike to an all-time high and this movement would never happen with a CBDC or a stablecoin. Cryptocurrencies are surely for the more risk-averse amongst us but can still benefit the general public if the essential research is done before investing into the crypto markets.

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