In the last year, stablecoins have exploded to a total market capitalization of $160 billion at heights. Simultaneously, central banks around the world are beginning to research and test the potential for central bank digital currencies (CBDCs). Given that both are designed to move money more efficiently–and despite the fact that a US CBDC would likely not use blockchain because it’s too slow at scale–the two are often presented in competition. In fact, if the US were to issue a CBDC, it is more likely to coexist with and complement already established privately-issued stablecoins. Before diving into the specifics of these mechanics, it’s important to define key concepts and provide background on both.
Not all stablecoins are equal or even “stable”: The term stablecoin in crypto is generally used to refer to a digital token that is designed to represent one US dollar (or other fiat currency) on a blockchain. While there are different stablecoin types–such as over-collateralized and fiat-collateralized–I focus on the latter because it can be the safest and closest to a CBDC. Fiat-backed stablecoins are backed by just that–fiat-denominated traditional currencies and assets. However, different fiat-collateralized stablecoins are backed by different assets depending on risk appetite. For example, Tether’s backing includes treasuries, cash and cash equivalents, corporate bonds, money market funds, commercial paper, digital tokens and more.1 USDP and BUSD, on the other hand, are just cash and US Government-guaranteed cash equivalents–nothing else. Additionally, while it is important to mention that there exist algorithmic coins that are designed to act stable, history has shown us that calling unbacked IOUs “stablecoins” is a stretch–Terra’s downfall is a perfect example.
Paxos only issues fully-regulated, 1:1 USD-backed stablecoins: Paxos stablecoins–USDP and BUSD–lead the market in stablecoin safety. As required by Paxos’ prudential regulator, they are backed only by cash, US Treasury instruments with maturities of 3 months or less, and overcollateralized US Treasury Overnight Reverse Repurchase Agreements.2 3 The reserves are held bankruptcy-remote in segregated accounts. They (along with Gemini’s GUSD) are the only fully regulated stablecoins on the market, since Paxos Trust Company and the individual stablecoins are regulated by the New York Department of Financial Services (NYDFS). As a result, a USDP or BUSD stablecoin is about as close to a US CBDC as the private sector has come. Today, USDP and BUSD have a combined market capitalization of about $18.5 billion.
CBDCs as digital cash: CBDCs can be thought of as digital cash–digital bearer instruments that are a direct liability of a central bank. Unlike other forms of money–a Venmo balance, bank deposits in a bank account, a check, etc.–CBDCs are not created by private entities such as a bank but instead are minted and issued by the government, just like dollar bills are today.
The future of a US CBDC is dependent upon design: While there has been robust discussion regarding the capabilities and implications of a CBDC, in practicality, the design of a future US CBDC largely depends on the choices of the US Federal Reserve and policymakers. Prior to Paxos, I was on the team at the Boston Fed that in February released a technical research paper on potential CBDC designs in partnership with MIT’s Digital Currency Initiative. As is clear from our paper, we spent significant time thinking about many of the different possible designs and use cases of a CBDC. However, through a privately-issued stablecoin lens, there were two key points that stood out: 1) a CBDC will likely be intermediated and 2) it will likely not use blockchain. Below, I dive deeper into the implications of both.
CBDCs would likely be intermediated: A CBDC being intermediated means that a bank or other financial institution will act as an intermediary between the Fed and the end users – i.e. everyday people like you and me are unlikely to go to the Fed to get our CBDCs to transact with on a daily basis. Today, customers get cash from their accounts at a commercial bank; a CBDC would likely be no different. The Fed would mint CBDCs and then push them to commercial banks and FIs just like it does with cash. Thus, depending on design–and whether it would be only available through intermediaries vs. also via self-hosted wallets–regulated stablecoins could be better positioned to improve financial inclusion. This is because stablecoins are on numerous public chains and can be stored and moved easily without the need for a central party–just like cash today.
Without a blockchain, CBDCs would need to be “wrapped”: The research designs put forth in the Fed’s February paper do not use blockchain because the technology does not meet the speed requirements needed to serve the world’s reserve currency. As a result, to be used in Web3 and on public blockchains, private companies–such as Paxos, Circle, and others–would need to “wrap” CBDCs and issue corresponding tokens on-chain, just like they do today with stablecoins. The main difference between a wrapped CBDC and a privately-issued stablecoin would be the backing–a stablecoin today at Paxos is backed by only cash and US Government-guaranteed cash equivalents in a bankruptcy-remote vehicle, whereas a Paxos-issued CBDC token would be backed directly by CBDCs. Thus, to those who see most future value being stored and exchanged on-chain, stablecoins and CBDC-backed coins would seem nearly interchangeable, while actual CBDCs would remain on the permissioned Fed-operated network.
Stablecoin use will explode during the +5-year CBDC design period: As Federal Reserve Vice Chair Lael Brainard stated in her testimony to the House Financial Services Committee on May 26, deciding on and designing a US CBDC is likely to take up to five years because of technological, design and privacy challenges, as well as other considerations lawmakers and regulators need to take into account. While that time is rightly needed to design, test and debate the best use cases for a CBDC–or whether one is needed at all–private stablecoins will continue growing. By the time a US CBDC is issued, regulated stablecoins could provide solutions that a CBDC may have been designed for–such as boosting financial inclusion, cutting transaction costs and settlement time, increasing access to USD, and even expanding the dollar’s role as the global reserve currency.
Depending on design, CBDCs could provide key benefits: While regulated stablecoins are well positioned to become the default way dollars are moved on-chain, there remain key use cases that CBDCs could support. For example, CBDCs could enable new fiscal policy options for the US government such as more effective Keynesian spending through more targeted stimulus benefits, more precise support through food stamps and rent subsidies, or even “tagged” CBDCs that could be spent only in certain places experiencing regional recessions. While there are many private sector solutions targeting remittances and cross border flow of funds, depending on design, CBDCs could also cut the cost to move money across borders. Additionally, depending on privacy specifications, CBDCs could give policymakers better economic data upon which to make policy. Finally, at a most basic level, a CBDC would offer the digital version of what cash does today: fulfilling a fundamental role of a government to provide citizens with a resilient, public way to store and exchange value in the economy that is not dependent on private companies or organizations.
However value is stored and exchanged in the future, both stablecoins and CBDCs are likely to have a leading role in the upcoming transformation of finance. Not only would this greatly expand the role of the USD globally, but it will also move money more efficiently and make a more inclusive and connected economy.