The Coronavirus Pandemic is causing us to rethink a lot of things. Physical cash is extremely beneficial for convenience, privacy and personal liberty. However, bank notes and coins are susceptible to transmitting pathogens among society as the physical money circulates. China has taken the step to quarantine physical cash for 14 days before allowing continued circulation, in hopes of rendering residual pathogens not viable.
At the same time, major central banks of the world are thinking about how a Central Bank Digital Currency (CBDC) could function. Many of the central banks are considering some kind of blockchain or distributed ledger design solution.
We’ve written before about “stablecoins” and their economic and technology-stack usefulness. Stablecoins endeavor to maintain a parity-peg with a target fiat currency, through various mechanisms. In doing so, they can be used economically to price and purchase items and can also be natively integrated into novel smart contract-based products and services. That is powerful, but their link to the underlying fiat is not guaranteed and relies on various things which could become compromised, such as third-party trust or oracle manipulation.
When we speak of “fiat” currency, we are really talking about sovereign nation issued currency. The translation of the Latin word “fiat” is “by authoritative decree”, or basically, “because I said so”. Sovereign nations have given themselves the ability to issue currency in this way, since all nations have removed gold-backed currency regimes.
So, would a CBDC be considered a stablecoin?
We don’t think so and here is our rationale: Stablecoins are issued by companies (e.g. USDC is issued by Circle Internet Financial, Inc.) or by groups (e.g. DAI is issued by MakerDAO), with the goal of maintaining price stability relative to the target currency. CBDCs will not be considered stablecoins because there is no peg relative to a benchmark, they are, in fact, the digital version of the national currency, accruing directly to a nation’s base money supply. In this sense, the idea of stablecoins seems an intermediate step in the progression towards blockchain technology legitimacy on the part of central banks.
Smart contracts, the technology upon which CBDCs would be based, enable incredible ideas to be natively embedded into the act of value transfer. However, they could also enable ideas that run counter to personal privacy and liberty to be directly implemented at the level of individual accounts, such as freezing, confiscation or even negative interest rates.
Today, many countries are acting with direct monetary stimulus to businesses and citizens to ease the impact of the current crisis. The US will mail checks to all households to be deposited in bank accounts. The resources and time spent in this effort alone will be considerable. CBDCs could achieve similar goals with far greater expediency, efficiency and directed impact. But: with great power comes great responsibility, and this is where the technology remains silent and our institutions must prove themselves on merit.
Asset Managers investigating tokenized assets must also be aware of the significance of currency tokens because assets are, after all, mostly traded against currencies. The payment leg of a trade is half of the equation in the “delivery versus payment” scheme. Funds will likely be hesitant to hold stablecoins issued by companies or groups and will strongly prefer CBDC tokens considered legal tender.
We believe the benefits of national CBDCs – direct, government-sanctioned fiat value – and their ability to use the rails of blockchain-enabled infrastructure will be immense. But there will be tradeoffs between these benefits and the privacy, liberty and individual sovereign custody that stablecoins can offer.