CBDCs vs. Stablecoins: Key Differences and What You Need to Know
Digital Currencies are generating more attention across various sectors and countries, and we may be closer to the end of the usage of physical cash than we think.
Also known as electronic currencies, digital currencies are in electronic form with a store of value that facilitates the payment of services or goods and the execution of transactions.
These currencies can only be transacted through a computer or a mobile phone, unlike fiat (banknotes) which can be transacted physically.
Over time, digital currencies such as Central Bank Digital Currencies and Cryptocurrencies (e.g. Stablecoins) have emerged, which have become popular amongst individuals, businesses, and the government.
However, the two currencies serve different purposes, and individuals, business owners as well as investors need to know these differences for informed decision-making.
What are Central Bank Digital Currencies (CBDCs)
Central Bank Digital Currencies (CBDCs) are digital currencies issued by the Central Bank of a country. Its value is fixed by the Central Bank and is equivalent to the country's physical currency. It can be used in similar ways to a physical currency such as making payments, as a reserve, or for settling transactions between businesses and financial institutions.
One of the major purposes of the creation of CBDCs is to bring about financial inclusion within a country.
The use of fiat currency in transactions requires various procedures that require physical presence and is most times cumbersome and physically draining.
These complexities have discouraged many individuals from participating in the financial system of a country. The introduction of CBDCs ensures ease, convenience, and accessibility to financial services, thereby encouraging more individuals to participate in the financial system.
Also, the introduction of CBDCs enables the efficiency of cross-border transfers and payments at low rates. CBDCs are built on blockchain technology which enables the transfer of money without any territorial limitations.
Some countries that have adopted the use of CBDCs include China (e-CNY), India (e-Rupee), Jamaica( JAM- DEX), Bahamas( Sand Dollar), Russia (Digital ruble) and others.
Types of CBDCs
Central Bank Digital Currencies (CBDCs) may be classified into two different types. They include:
Retail CBDCs: These are digital currencies that may be used to transact between consumers and businesses. Essentially, Retail CBDCs are for general public use.
Retail CBDCs may be of two kinds; token-based and account-based. Token-based Retail CBDCs allow users to transact with each other using public and private keys to execute transactions anonymously. Account-based CBDCs require the users to have a verified account to execute transactions.
- Wholesale CBDCs: Wholesale CBDCs are not intended to be used by the general public, rather it is to be used to make transactions between banks and financial institutions. These transactions are usually of high volume and mostly infrequent.
What are Stablecoins?
Stablecoins are a type of cryptocurrency where the value is pegged to another asset like the United States dollar (USD), gold, or any other commodity to keep its value fixed or stable.
The volatility and constant fluctuation of the values of some cryptocurrencies make it an insufficient and unreliable choice for carrying out daily transactions.
Stablecoins were developed to tackle this issue of instability, by tying the value of the currency to a stable asset. Stablecoins have become an attractive choice for retailers, institutions, and business owners for facilitating trades within and across borders.
Types of Stablecoins based on Backing Mechanisms
Stablecoins can maintain value through mechanisms that act as a backing to ensure the stability of their value. These mechanisms include:
- Fiat-backed stablecoins: These are stablecoins that are backed by fiat currencies such as the United States dollar (USD) and the European Union Fiat Currency (EURO). The stablecoins are pegged to the fiat currency at a ratio of 1:1 where the reserves of the fiat currency act as collateral ensuring the stability of the coin. Some examples of fiat-backed stablecoins include USD-pegged Tether (USDT), United States Coin (USDC), Binance USD (BUSD), and EURO-pegged Stasis (EURS).
- Crypto-backed stablecoins: These are stablecoins backed by the reserves of other cryptocurrencies. To ensure that these stablecoins retain a fixed value, the value of the assets in the reserves is greater than the pegged value to mitigate the volatility of the crypto assets. An example of a crypto-backed stablecoin is DAI which is backed by Ethereum coin (ETH) which is maintained by a smart contract run by MakerDAO. To ensure the stability of DAI, users mint DAI by depositing ETH as collateral.
- Algorithmic stablecoins: Algorithmic stablecoins rely on programmed mechanisms and smart contracts to manage the supply of the coin in circulation. Where the market price falls below the fiat currency price it follows, the number of tokens in circulation is reduced. On the other hand, where the market price goes above the fiat currency price it follows, the supply of tokens in circulation increases to stabilize the value of the token. An example of an Algorithmic Stablecoin is Ampleforth (AMPL). It must also be noted that stablecoins backed by algorithms may not be sustainable long term as seen in the collapse of TerraUSD (UST).
- Commodity-backed Stablecoins: These are stablecoins backed by physical assets such as gold, precious metals, real estate, and oil, which act as collateral to ensure the stability of the coin. The most popular commodity backing stablecoins is gold. Examples of Gold backing stablecoins are Tether Gold ( XAUT), and Paxos Gold ( PAXG). It is important to note that these commodities may suffer from fluctuation in price, which may affect the values of the backed stablecoin. However, commodity-backed stablecoins afford holders to gain exposure to these commodities and even exchange the stablecoins for these commodities.
Key Differences between CBDCs and Stablecoins
Central Bank Digital Currencies and Stablecoins are both digital currencies that have a store of value and can be used to facilitate transactions. However, certain factors distinguish these two digital currencies.
Here are some of the differences between CBDCs and Stablecoins:
| Central Bank Digital Currencies | Stablecoins |
| CBDCs are issued by the Central Bank of a country | Stablecoins may be issued by private individuals, private institutions, or decentralized entities.
|
CBDCs serve as the national currency of a country and just like physical cash are backed by the cash reserves in the country |
Stablecoins are backed by Fiat currency, commodities, cryptocurrency assets, and algorithms.
|
CBDCs are fully regulated by the relevant regulatory agencies and institutions |
Stablecoins may be partially regulated depending on the private individuals or institutions that issue the coin. It may also be completely unregulated if issued by decentralized entities |
CBDCs serve as the legal tender which is a recognized and official payment mechanism of a country |
Stablecoins are issued by private bodies and cannot serve as the official legal tender of a country.
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The government is in full control of the issuance and usage of CBDBs. |
Control over stablecoin is either by a centralized or decentralized private body.
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CBDCs are governed and regulated by the government and as such transactions can be monitored and tracked by the government leaving little room for privacy. |
Stablecoins offer a higher degree of privacy as transactions are not tracked, especially for stablecoins issued by decentralized bodies.
|
Adoption of CBDCs and Stablecoins
Central Bank Digital Currencies(CBDCs) are electronically issued currencies that serves as an alternative to physical currency within a country.
The adoption of CBDCs will reduce the tension of the physical currency, promote financial inclusion, ensure seamless cross-border transfer of funds, and facilitate better delivery of financial services.
With CBDCs, it is more efficient to monitor and control the money in circulation and adhere to regulatory compliance. This brings about improvement in the country's monetary policy.
Stablecoins are digital currencies issued by private individuals or bodies. Its value is fixed, making it a perfect use case for domestic and trans-border transactions.
Beyond its use as a payment medium, stablecoins play an important role as a less volatile option for traders who engage in Decentralized Finance (DeFi) or any other type of cryptocurrency trading.
Potential Future of CBDCs and Stablecoins
The massive adoption of stablecoins for facilitating payments, remittances, and even for storing funds has revealed the potential of a stable digital currency.
This undoubtedly influenced the development of Central Bank Digital Currencies (CBDCs) by various nations as an alternative to fiat currency.
Certain concerns have emerged as to whether both digital currencies can co-exist or whether there shall be competition for dominance in the digital payment field.
The coexistence of both digital currencies is possible as they serve different purposes. CBDCs operate as legal tender of a nation whose functions go beyond payment, while stablecoins operate as digital currencies issued by private bodies capable of facilitating transactions.
However, certain challenges could affect the existence of both currencies. Central Bank Digital Currencies (CBDCs) may suffer from continuous monitoring by governmental agencies which could threaten the privacy of individuals. On the other hand, most stablecoins remain largely unregulated creating a lack of accountability in instances where losses may be suffered where de-pegging occurs as seen in the case of the collapse of TerraUSD (UST).
Similarly, the digital nature of both currencies makes them susceptible to cyber attacks such as hacking, phishing, etc, which could destabilize the financial economy.
The recent developments in blockchains in terms of privacy and security as well as the enactment of regulations like Market- in- market-in-crypto assets (MiCA) are welcomed attempts at a successful digital financial system. There is a need for more collaborative efforts from blockchain developers and policymakers in shaping these currencies as the future of a global financial system.
Conclusion
Central Bank Digital Currencies (CBDCs) and Stablecoins are two interconnected yet distinct types of digital currencies.
This is seen in the backings, issuance, control, and intended use cases of both currencies. Therefore, knowing that there is a clear distinction between both currencies is important.
Nonetheless, both currencies play a vital role in shaping the future of the global financial systems where territories and borders are no longer barriers.
Please be advised, that this article or any information on this site is not an investment advice, you shall act at your own risk and, if necessary, receive a professional advice before making any investment decisions
Roman Klochko