Why governments should regulate stablecoins instead of developing CBDCs

Governments and central banks worldwide are increasingly exploring the potential of central bank digital currencies (CBDCs) to modernize financial systems, enhance payment efficiency, and improve financial inclusivity. This surge in interest is evidenced by numerous pilot projects and research initiatives across different countries, aiming to harness blockchain and other underlying technologies to create a sovereign digital currency.

Amid this global trend toward digitalization, the crypto industry has positioned itself at the forefront of critical discourse, raising significant concerns about the potential ramifications of CBDCs. Industry leaders and enthusiasts advocate for preserving financial privacy, decentralization, and user autonomy, highlighting the risks associated with increased governmental control over digital currencies. These concerns underscore the industry’s apprehension about the potential for CBDCs to centralize financial power, as it contradicts the foundational principles of cryptocurrencies.

Despite the industry’s resistance, the trajectory towards digital currencies appears unstoppable. Governments are unlikely to abandon the pursuit of digitizing their currencies, driven by the advantages of streamlined transactions, enhanced security measures, and the potential to combat illicit financial activities.

However, a compelling alternative exists that aligns more closely with the ethos of the crypto industry—stablecoins. These digital assets offer a bridge between the volatile world of cryptocurrencies and the stability of traditional fiat currencies, presenting a solution that could satisfy regulatory standards and market needs with significantly less governmental effort.

The integration and regulation of stablecoins present an opportunity to leverage existing digital currency infrastructure, promoting innovation and efficiency within the financial system. Yet, the preference among governments for developing their CBDCs over regulating stablecoins remains a formidable challenge.

In this report, CryptoSlate will dive deep into the potential benefits and practicalities of prioritizing stablecoin regulation, exploring why such an approach could serve both public and private interests more effectively than the current focus on CBDCs. Despite the improbability of this shift in governmental priorities, the analysis aims to show the advantages of stablecoins as a complementary or alternative mechanism to digitize the economy.

Stablecoins represent a critical innovation within the cryptocurrency sector, designed to bridge the gap between digital currencies’ volatile nature and traditional fiat currencies’ stability. The genesis of stablecoins can be traced back to the launch of Tether (USDT) in 2014, which pioneered the concept of a cryptocurrency pegged to the value of the US dollar to mitigate price fluctuations.

Stablecoins can be broadly categorized into fiat-collateralized, crypto-collateralized, and algorithmic stablecoins. Fiat-collateralized stablecoins maintain a reserve of traditional currency as collateral, crypto-collateralized variants use other cryptocurrencies as backing, and algorithmic stablecoins aim to maintain their peg through software algorithms without direct backing.

The utility of stablecoins extends across various domains within the digital economy, including facilitating trading on cryptocurrency exchanges, serving as a medium for remittances, and enabling stable digital payments. As of Feb.1, 2024, stablecoins account for a significant portion of the cryptocurrency market, with a combined market cap of $134.13 billion.

The technical infrastructure of stablecoins involves sophisticated blockchain technology for creation, listing on multiple blockchain networks, and mechanisms for redemption.

Central Bank Digital Currencies (CBDCs) are digital fiat money issued and regulated by central banks. They aim to improve payment efficiencies, enhance financial inclusion, and maintain the sovereignty of national currencies in a digital form. The exploration and development of CBDCs have accelerated in recent years, with several countries conducting pilot projects or research into their implementation.

The technical foundation for CBDCs involves creating a digital currency platform, potentially using blockchain or distributed ledger technology, with a consensus mechanism to validate transactions and processes for the digital currency’s creation and redemption.

CBDCs are intended for a wide range of uses, including streamlining domestic and cross-border payments, reducing transaction costs, and increasing the accessibility of financial services. The first significant ventures into CBDCs have been varied, with the Bahamas launching the Sand Dollar in 2020 as one of the first fully implemented CBDCs.

Numerous high-profile CBDC projects are underway, with countries like China, Sweden, and the European Union at different stages of exploration and development. These projects illustrate the diverse approaches to integrating digital currencies into existing financial systems, each with unique technical requirements tailored to national monetary policies and infrastructural capabilities.

While stablecoins and CBDCs share the goal of digitizing currency, they originate from fundamentally different premises within the financial ecosystem. Stablecoins emerge from the private sector, seeking to leverage the benefits of blockchain technology for stability and efficiency. In contrast, CBDCs represent an official response to the digital economy, aiming to preserve monetary sovereignty.

Stablecoins have cemented their role as an indispensable component of the crypto market, facilitating a seamless bridge between fiat currencies and crypto.

Their intrinsic value is derived from their ability to offer price stability in an otherwise volatile market, making them an ideal medium for transactions, savings, and hedging against crypto market fluctuations. With the market capitalization of major stablecoins like Tether (USDT) and USD Coin (USDC) reaching $96.17 billion and $26.9 billion, respectively, their integration into the digital economy is undeniable and expansive.

The scalability of stablecoins is a noteworthy advantage, particularly when considering their potential to meet the needs of a digital fiat currency at a national or even international level. For instance, the infrastructure underpinning leading stablecoins allows for processing transactions at a fraction of the cost and time required by traditional banking systems.

This efficiency, coupled with the ability to maintain stable value, positions certain stablecoins as viable candidates to function alongside or even in place of traditional fiat in digital form. Their scalability is further enhanced by the existing global infrastructure of the cryptocurrency market, which can facilitate instant cross-border transactions without the need for intermediaries.

Moreover, stablecoins inherently possess an innovative edge characteristic of the private sector. This innovation stems from the competitive nature of the cryptocurrency market, where continuous improvements and technological advancements are essential for survival and growth. This environment fosters agility and responsiveness to user needs that traditional financial institutions and government-issued currencies struggle to match.

The international reach of stablecoins is another defining feature that differentiates them from CBDCs. Unlike CBDCs, which are designed with a national focus and subject to the regulatory and monetary policies of their respective issuing countries, stablecoins operate globally.

They enable users from different jurisdictions to engage in transactions without worrying about exchange rates or cross-border fees. This international utility of stablecoins facilitates economic interaction and integration not easily achievable by CBDCs, which are inherently limited by their national scope.

In comparison, the usage of stablecoins transcends borders, offering uniformity and consistency in transactions across the globe. This global accessibility and usability starkly contrast to the inherently localized nature of CBDCs, which, while revolutionary in their own right, are designed to serve the specific economic and regulatory needs of their issuing country.

The comparative analysis between the borderless operation of stablecoins and the national focus of CBDCs highlights a crucial advantage of stablecoins in fostering a more interconnected and efficient global financial system.

The journey of stablecoins through the regulatory landscape has been fraught with challenges and scrutiny. Regulatory bodies worldwide have expressed concerns over consumer protection, financial stability, and the potential for money laundering and terrorism financing through stablecoins. Specifically, stablecoin issuers have faced questions regarding the sufficiency of their reserves, the transparency of their operations, and their adherence to existing financial regulations.

The collapse of algorithmic stablecoin TerraUSD (UST) is a prime example of the volatility and risk associated with poorly regulated stablecoins, highlighting the potential for significant market disruptions and loss of user funds.

However, a well-constructed regulatory framework could serve as a powerful catalyst for the growth and stability of the stablecoin market. By establishing clear guidelines for reserve management, operational transparency, and legal compliance, regulators can enhance the credibility and reliability of stablecoins.

This, in turn, would likely accelerate their adoption by providing a safer environment for consumers and businesses alike. Regulatory clarity could also facilitate the integration of stablecoins into traditional financial systems, expanding their utility in areas such as payments, remittances, and settlement processes.

The economic benefits of a regulated stablecoin market are manifold. For one, increased stability and trust in stablecoins could spur greater use in daily transactions, reducing reliance on traditional banking systems and lowering transaction costs. Furthermore, regulation could unlock the potential for stablecoins to act as a bridge between fiat currencies and cryptocurrencies, enhancing liquidity in the crypto market and fostering greater financial inclusion.

Regulating stablecoins like USDT and USDC over developing and implementing CBDCs would leverage existing infrastructures and ecosystems, potentially enabling quicker and more cost-effective integration into the financial system. In contrast, CBDCs require the establishment of new technological and infrastructural frameworks, which could entail significant investment and time.

The technological and infrastructural requirements for regulating stablecoins encompass robust systems for monitoring and enforcing compliance with reserve requirements, anti-money laundering (AML) and counter-terrorism financing (CTF) standards, and user protection measures. This would necessitate collaboration between stablecoin issuers, blockchain technology providers, and regulatory bodies to ensure stablecoin operations are transparent, secure, and aligned with broader financial regulatory goals.

Governments and central banks worldwide are increasingly advocating for the development of Central Bank Digital Currencies (CBDCs), emphasizing the need for sovereign control, financial policy integration, and systemic stability. The core of this advocacy lies in the belief that CBDCs provide an unparalleled opportunity for central banks to exercise direct oversight over the digital financial ecosystem, ensuring the integrity and security of national financial systems.

Sovereign control is a primary motivator behind the push for CBDCs. Unlike decentralized cryptocurrencies or even stablecoins, which operate on global platforms and are often issued by private entities, CBDCs would be wholly controlled by central banks. This control enables governments to enforce anti-money laundering (AML) and counter-terrorism financing (CTF) standards more effectively and manage monetary policy directly.

Integrating CBDCs into existing monetary policies offers another significant advantage, facilitating more precise and dynamic monetary interventions. CBDCs can be designed to work seamlessly with existing financial infrastructures, enabling central banks to implement monetary policy changes directly through the digital currency system. This could enhance the effectiveness of fiscal stimuli or contractions, interest rate adjustments, and liquidity management within the economy.

From a government’s perspective, the challenges and risks associated with the widespread adoption of stablecoins in lieu of developing CBDCs are considerable. Stablecoins, particularly those not fully backed by traditional currencies or assets, can pose significant risks to financial stability. Without central oversight, the failure of a major stablecoin could trigger systemic shocks. Moreover, the reliance on stablecoins backed by other currencies might undermine national currencies, affecting monetary sovereignty and policy effectiveness.

An exclusive focus on stablecoin regulation is highly unlikely due to various political and economic factors and strategic interests. National governments are vested in maintaining monetary sovereignty, which is integral to economic independence and security.

The ability to issue currency, regulate money supply, and set interest rates is central to a nation’s economic strategy and ability to respond to crises. Therefore, the transition to a digital economy is seen not merely as adopting new technology but as a strategic move to preserve these capabilities in the face of evolving financial technologies and practices.

While the innovation and efficiency offered by stablecoins are recognized, the strategic imperatives of monetary sovereignty, financial stability, and policy integration guide governments’ preference for CBDCs.

The discourse surrounding the future of digital currencies is multifaceted, with stablecoins and Central Bank Digital Currencies (CBDCs) representing two pivotal yet distinct approaches to the digitization of finance.

Stablecoins, with their roots deeply embedded in the crypto industry, offer a bridge between the volatile world of cryptocurrencies and the stability and familiarity of fiat currencies. Their adaptability, efficiency, and global reach make them a compelling tool for instant transactions and remittances and as a stabilizing force within the crypto markets.

While significant, their regulatory challenges highlight the opportunity for a regulatory framework that could enhance their stability, trustworthiness, and broader economic utility.

Conversely, CBDCs embody the institutional response to digital currency, aiming to harness the benefits of blockchain technology while maintaining sovereign control over monetary policy and financial stability. The strategic push for CBDCs underscores governments’ desire to innovate within the confines of traditional regulatory and monetary frameworks, ensuring that digital currencies align with national interests and policy goals.

The juxtaposition of stablecoins and CBDCs is a perfect example of the broader narrative of digital currency evolution—a narrative characterized by the tension between innovation and regulation, global reach versus sovereign control, and the quest for financial stability in an increasingly digital world.

As time goes by, it becomes evident that the confluence of these approaches will likely shape the future of finance. Exploring all avenues for digital currency advancements, including the thoughtful regulation of stablecoins and the strategic development of CBDCs, is paramount. Such exploration not only promises to enrich the financial landscape but also to ensure that the transition to digital currencies is inclusive, efficient, and aligned with the broader economic and societal interests.