Blockchain & Digital Money: Adoption of CBDC and Stablecoins

Nowadays, one of the best keyword-conversation-topic among plenty of tech-enthusiast is the disruptive effect of the financial industry digitalization. How technologies like blockchain and machine learning will improve transactions and back-office processes. And even, how digital assets will enhance transactions by making it all electronic. But, the truth is, our financial system is pretty much digital. 

Think about it. Most of our financial interactions are digital – and even more so since the digitalization jump that Covid-19 made us take-. Money, for most of the developed world, basically only numbers ticking up and down in bank accounts. Hence, the majority of the money currently circulating is digital, not paper, especially those dollars/euros/pounds that have been printed as financial aid packages. 

And part of that digital money out there in the world actually comes from banks making loans. It works, in simple words, just by typing numbers. For instance, say you need a hundred thousand dollars to found a competitive e-sports team. The bank checks out your credit history, and they’re like, you’re good. So, they decide to give you the money. The loan officer will type some numbers into his or her computer, and your account balance is going to increase by $100,000. 

It’s that simple (almost). The bank officer isn’t thinking about cash. They are not going down to the vault and counting 20s. Where did the bank get the money to make the loan? Well, it got it from the keyboard, right? It was a one followed by a number of zeros. Call it the “power of the keyboard”. Banks have it. And, as recent studies lead by the economist Stephanie Kelton (2019) about Modern Monetary Theory, so does the government.

But, this is not new. What is new is the appearance of new technologies that could support all the financial infrastructure for it to be, not only more efficient but also cheaper and more transparent.

The whole financial system could be interconnected. And so, citizens around the world could use their sovereign currency frictionlessly, as same as businesses, improving the whole economic system with the efficiency and transparency boost. 

All of this can be possible through Distributed Ledger Technologies (DLT), and there has been a lot of research on the matter. Institutional interest aims to keep the pace of the digitized payment systems and the increasing retail interest towards capital markets.

Central banks and big corporations around the world have been actively exploring the possibility of introducing digital currencies. Central bank digital currency (CBDC) and Stablecoins, represent the digital alternative to cash that many policymakers and multinational companies are proposing to engage with the ongoing digitalization of payment means and global business processes.

And there is a lot of hype about it, but… 

Is the financial system integration to DLT’s feasible?

In a word “YES”. Nevertheless, there are limitations and challenges that need to be solved before its total integration. Researchers from both the institutional side and the corporate side have accumulated plenty of studies on the topic, evaluating all the benefits and the barriers that this integration brings. 

Recently, the Deutsche Bundesbank, Deutsche Börse, and German Finance Agency developed a test where the Federal Government’s Finance Agency issued a ten-year Federal Bond (known as Bund) in the DLT system (tokenized Bund) with no legally binding obligation. The participating parties were Barclays, Commerzbank, Société Générale, DZ Bank, Goldman Sachs and Citibank (Deutsche Bundesbank, 2021). They wanted to establish a settlement interface for electronic securities, and it had a positive result. This is one of a few experiments governments have made in an attempt to integrate Distributed Ledger Technologies into their own structure. This confirms that all the benefits are available, we just need to undertake adoption.    

Adding to the technical research, a European Central Bank (2020) survey, found that “young Europeans make extensive use of cash but have a preference for electronic payments and expect the related infrastructure to guarantee safety and speed” (ECB, 2020). A certainty that encourages the use of stablecoins and Central Bank Digital Currencies as a solution for payments settlement. 

In fact, retail adoption of electronic money issued through blockchain and other DLTs is increasing. Now, more than ever, people are investing in new asset classes that are being powered by these disruptive technologies. Coinbase, the leading crypto asset exchange in the United States, increased its revenue from 438 million dollars in 2019 to $1,140 million in 2020, reaching 43 million users.

So, understanding the possibilities and challenges raised with the emergence of DLT-based digital money is crucial to understand the economic paradigm of the future. Thus, this article analyzes the changes in digital payment solutions, along with an update on the CBDCs adoption and the benefits and challenges for the financial industry.

1. The differences between CBDC’s and Stablecoins

In search of the price stability of crypto assets, stablecoins were introduced. Stablecoins are digital units of value that rely on a set of stabilization tools and minimize price fluctuations. They are backed by funds (tokenized funds), other traditional asset classes (off-chain collateralized stablecoins), by assets as crypto-assets (on-chain collateralized stablecoins), or by users’ expectations about the purchasing power of their holdings (algorithmic stablecoins) (Bullman et al., 2019). 

One of the most traded stablecoin is the USD Token (USDT, also known as Tether), which is —partially— backed by the US dollar (74%), maintaining its value near 1. In comparison to crypto-assets as Bitcoin and Ether, Tether volatility remains low, and it is used massively on the retail side to access other cryptocurrencies. Tether, with a market capitalization of $2.8 billion, is a key source of liquidity for exchanges and traders around the world. In fact, according to the research site CryptoCompare, about 80% of all bitcoin trading is done in USDT.

Stablecoins are increasingly being used in the dApp economy, and now it has been integrated with digital payment networks like Visa (Business Wire, 2021). These types of integrations with traditional payment platforms will promote and facilitate wider acceptance of dApps. On the other side, this growth is complemented by the possibility of a digital euro/ CBDC euro issuance.

As explained before, “power of the keyboard”, or the way central banks are able to issue new digital money, can be directly improved through CBDCs. That is why many central banks around the world are exploring different ways of adopting DLT for their monetary system. However, this works only for governments that control their own currency – currency that’s backed by nothing but the government’s good name. Currencies that are not pegged to another currency. Such as the Fed, the European Central Bank, and the Bank of Japan, to name a few. 

Europe, with the European Central Bank (ECB) and the Bank of England, issuing two of the most important currencies in the world, has been doing extensive research about the digital money enabled through decentralized technologies. 

The ECB plays a central role in the financial stability of Europe, as a multinational economic block. They address the issue of inflation and contribute to the safety of the European banking system. Understanding the massive impact of CBDC on the European and international economic system, they have developed pilot programs to explore all the adoption possibilities. 

As an important global player, their conclusions can be taken and replicated by other countries, and will definitely affect businesses around the world, given the importance of the European Economic Area. Hence, it is important to consider their findings, as a highly influential benchmark for the emerging digital monetary reality. 

The ECB has concluded that the principles of a digital euro/CBDC euro should be:

• The CBDC euro should be convertible at par, NOT a parallel currency.

1. The CBDC euro should be a liability of the Eurosystem, meaning a digital euro is central bank money and its issuance is controlled by the Eurosystem.
2. The CBDC euro must be widely accessible on equal terms in all euro area countries through supervised service providers.
3. The CBDC euro should be market neutral: Not to crowd out private solutions.
4. The CBDC euro must be trusted by end-users: Trusted solution from the start and over time.

In addition, the following requirements must be achieved:

1. The CBDC euro should be an attractive means of payment and should not be used as a form of investment or avoid the associated risks of large shifts from private money to digital euro, like bank deposits.
2. The CBDC euro should be made available on an equal basis in all euro countries through supervised intermediaries.
3. In issuing the digital euro, the Eurosystem should comply with regulatory standards, including in the payment area.
4. The CBDC euro should be designed in a safe and efficient way.
5. “The digital euro should be made available through standardized front-end solutions throughout the entire euro area and should be interoperable with private payment solutions”.(European Central Bank, 2020).

The preceding principles would make CBDC’s a different kind of crypto-asset. It would be a risk-free form of central bank money and would be a liability to the ECB. A contrast from Stablecoins, where the risk depends on the collateralized asset. Although stablecoins have proven to be more stable (with collateralized fiat as USDC and USD Tether) than crypto assets, according to the European Central Bank (2020) they cannot ensure long-term stability. 

Therefore, it is highly probable that a government solution will be issued in the future generating a more stable environment and a base infrastructure (legal, financial, and economical) for the development of decentralized applications (dApps). To learn more about Central Bank Digital Currencies and their benefits read our piece on CBDCs:  “Central Bank Digital Currency (CBDC) — How DLT-systems can boost economic growth”.

Previously, we touched upon the fact that most of the circulating money is actually digital. Even more so now, that the COVID-19 crisis has induced an important shift from cash to digital cash. Digital payments increased in response to the need for contactless transactions avoiding the spread of the virus. The crypto-asset market is no exception. Coinbase, the leading crypto asset exchange in United States, increased its revenue from $438 million dollars in 2019 to $1,140 million in 2020 reaching 43 million users. Even though cash remains the dominant means of payment in the euro area, it is declining in many countries.      

As a response, leading payment networks as Visa have integrated their products to Distributed Ledger Technologies. Visa made a partnership with Anchorage, a formal digital bank, to settle transactions in USD Coin (USDC) within the Ethereum Blockchain. USD Coin is a stablecoin with the USD dollar as collateral, meaning USDC partners keep USD on bank accounts in the same proportion as the tokens’ issuance (Visa, 2021). This integration allows consumers that hold USDC in their wallets to send this currency to Visa’s Ethereum wallet and settle transactions. Consequently, the merchants get paid by Visa in their own currency (Dillet, 2021).       

Another integration example can be seen in Paypal, where United States residents can buy, sell and hold cryptocurrencies directly through Paypal using their personal Premier PayPal Cash/plus account. Currently, transactions are limited to be traded in USD which might change in the near future. 

With all of these advancements, It is clear the growing trend towards DLT-payment systems.  DLT brings plenty of improvements and appliances due to benefits such as faster and cheaper transactions, accessibility, transparency of records and liquidity. 

Benefits for the financial industry   

The financial sector has a positive outlook on DLT’s as Blockchain. It has the potential to carry out the settlement of financial transactions automatically (Deutsche Bundesbank, 2019). CBDC and stablecoins represent an opportunity to settle transactions more efficiently in a national and international environment. 

With processes being transparent, cheaper and faster, and governments supporting these initiatives, the results are expected to yield multiple benefits. The whole system is creating a sustainable and safe digital payment infrastructure that protects all agents of the economy.        

micobo takes part in this process by offering a safe and reliable platform to tokenize assets incorporating Anti-Money Laundering (AML) and Know Your Customer (KYC) processes, which is one of the key issues for regulators. Integrating these advancements on payment systems, our solution allows for investment subscription to be done through stablecoin —cash-on-ledger solution— using an ERC-20 standard, allowing for all the transactions to be settled on the ledger. 

Our client’s investors can do their initial deposit transfer in fiat and they would receive the stablecoins on their digital wallets, through an automated minting process running in our backend. And so, all futures transactions within the digital investment process (primary and secondary markets), can be done on the ledger. Hence, when token issuers want to distribute dividends or any sort of return to their investors, this distribution process is done efficiently and on-chain, removing intermediaries. 

Using a stablecoin in our enterprise infrastructure, micobo offers easier and safer trades, based on tokens. Through state-of-the-art technological infrastructure, we create a better financial environment for stable and cheaper financial transactions, yielding higher returns for issuers and investors. 

If you are interested in knowing more about this game-changing technology, contact us and request a demo of our DLT-based White Label Solutions, thought to increase the efficiency of financial systems and offer great growth potential for all types of business.

About micobo

micobo GmbH is a leading European software company for Security Token Offerings and Blockchain Software Development (DLT). It provides fully compliant software solutions for Security Token Offerings and advises on structuring DLT- and Blockchain-based Securities. micobo empowers financial institutions with state-of-the-art technology focusing on providing a better customer experience and achieving measurable results.

Authors

Laura Andrade (la@micobo.com)

Luisa Blandon (lb@micobo.com)

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