April was full of stablecoin politics, perpetuating the idea of a global race to tokenize cash. In my opinion, this is not a single race – it’s a competition across several disciplines. We should cheer for the right to compete freely rather than for one winner.
Mid-April, the U.S. House Financial Services Committee proposed a bill to regulate fiat-backed payment stablecoins while restricting any other backing mechanisms, and instructing the Fed to study the digital dollar. Fast forward to last week, when Republican presidential candidates rallied against the idea of a digital dollar, calling it a China-inspired surveillance tool.
Dea Markova is a managing director and head of digital assets at Forefront Advisers.
In Europe, the European Central Bank (ECB) is losing political support for the digital euro. Yet, the ECB declared last Monday that its investigation phase is progressing at pace towards an October deadline. Being ahead of the U.S. and U.K. has forced Europe to face some of the really tough CBDC questions: Can you roll out a public tokenized instrument at a large scale? What is a feasible commercial model? What are the use cases? How is privacy safeguarded?
Although privacy gets tossed around like a political hot potato, the other three questions are, in my opinion, much harder to answer. For the avoidance of doubt, with just a few months left on the ECB timeline, they have not been answered convincingly.
Also in April, Société Genéralé launched a euro stablecoin on Ethereum, available to know-your-customered (KYC) institutional clients and giving them direct access to their locked collateral. EUR CoinVertable will be credit-rated. A day later, the crypto developer community criticized SocGen for embedding functions that allow it to empty their clients' wallets, and which require a centralized validation of each transaction – you know, like a bank does.
Read more: Dea Markova – Is Europe’s MiCA a Template for Global Crypto Regulation?
Meanwhile, banks around the globe are looking for models to tokenize their deposits in a way that somehow gels with KYC requirements and makes sense for deposit guarantees. The Bank for International Settlements (BIS) suggested in early April that the best way to do so was in two steps.
Step one: Give up on the idea of stablecoins as bearer instruments. The logic that “he who holds it, owns it” cannot work with KYC rules, it said.
Step two: Tokenize deposits and replicate the commercial bank settlement system via a wholesale CBDC. That way you avoid the issue of converting, say, ING coin to HSBC coin, said the BIS.
The Bank of England thinks tokenized deposits are “regulatorily simpler” (aka a good thing) and that a bank had better issue stablecoins from a separate entity. Pay attention to the latter.
These recent developments are great examples of the strengths and weaknesses of the various types of tokenized money we have emerging. We have four credible options on the table – fiat-backed, nonbank-issued stablecoins such as USDT and USDC, fiat-backed bank-issued stablecoins such as EUR CoinVertable, CBDCs and tokenized deposits.
They are all competing for market share, and the race will only intensify as the contenders gain maturity. Politicians are often tempted to talk of a winner-takes-it-all scenario. For the ECB, that winner is the digital euro.
I would argue this is not a race. We are watching the "Stablecoin Olympics," with contenders competing across different disciplines. Not one is equipped to win them all at the same time.
The disciplines are five: trust, credit risk, interoperability, cyber risk and profitability.
Trust is the Olympic event that CBDCs can win most convincingly. While concerns with privacy and surveillance come up loudly, the vast majority of the market would agree that the central bank is the institution in a country which they trust the most. The nations where this faith is thin are exceptions. That is why banks in Europe are so worried that if they could, depositors would rather keep their savings with the ECB. The ECB, in particular, is also spending a good amount of effort on privacy protections.
Credit risk is a closely linked discipline. Stablecoins carry the risk of wherever their reserve funds are held. Commercial banks carry their own risk. CBDCs carry the risk of the sovereign. I would watch this space for credit scoring as a way to predict who gets the medals.
The interoperability race, for now, goes to private stablecoins. They are the most liquid instrument on the market. Circle, issuer of USDC, just launched a cross-chain protocol, too. Most institutional projects utilize permissioned ledgers, which by definition limit access and interoperability. As the BIS research flags, there are also significant design complexities to interoperability between tokenized deposits.
The cyberattack event is too close to call. The choice of a ledger, whether open or proprietary, proof-of-work or proof-of-stake, makes all the difference. Many in the community would contest that the Bitcoin blockchain is the safest one out there if safety is the ultimate goal. In European Union regulation, both stablecoin issuers and banks will be subject to a cyber law called DORA. Hence, the operational resilience safeguards applicable to their choice of technology will be the same.
Last but not least is profitability. A sustainable form of future money has to be profitable for its issuers – unless it is a subsidized public utility. In a high interest rate environment, this is less of an issue. Stablecoin reserves are, or will be when regulated, predominantly in government bonds. In a low-interest environment, however, it is currently much easier to see how tokenized deposits can make money on the banks’ fractional reserves model.
The Stablecoin Olympics will progress driven by regulatory choices and organizational behaviors. Some structures are set to innovate faster, others to risk manage better. Politics and perceptions matter for partnerships and financial stability. As consumers, our best outcome is to arrive at a marketplace of tokenized cash, where we get to pick our champion based on our use case.