Are CBDCs the missing piece in the crypto ecosystem?

Yesterday, the Bank for International Settlements (BIS) published the results for its 2022 survey on Central Bank Digital Currencies (CBDCs) and cryptocurrency.

The paper itself reveals several trends within the cryptocurrency industry, as well as an update on CBDC development around the world.

In short, the study found that CBDC development was on the rise throughout 2022, with 93 per cent of central banks surveyed saying that they were engaged in some form of CBDC work.

Primarily, central banks that were interested in creating a retail CBDC hope to improve financial inclusion and payments efficiency, while wholesale CBDCs are used to pursue better cross-border payments. In this vein, CBDCs and fast payment systems are seen as complements, and most central banks see value in having both a retail CBDC and a fast-payment system.

The BIS also reports that today, there are four live retail CBDCs, but that by 2030, there may be 15 retail and nine wholesale CBDCs.

Yet, the report also points out that part of the reason why so many central banks are intent on researching and working on CBDCs is that the crypto space has seen significant developments over the past two years.

According to the report, “The year 2022 and the beginning of 2023 were characterised by strong turbulence in the crypto market. In the first half of May 2022, the crypto ecosystem was shaken up by the failure of various cryptoassets,.. If widely used for payments, cryptoassets including stablecoins may constitute a threat to financial stability.

60% of central banks said that the emergence of stablecoins and other cryptoassets has accelerated their work on CBDCs. These central banks generally attach more weight to a broader set of motivations for issuing a CBDC. In particular, their retail and wholesale CBDC work is driven more often by financial stability and payments efficiency reasons.”

Are regulators anti-crypto?

Certainly, many in the crypto space have raised concerns about CBDCs and the various threats that they may create to individual privacy.

And the fact that central bankers have revealed that CBDCs are in development in response to the increased popularity of cryptocurrencies and crypto assets is certainly not helping to endear them to the industry.

But we should also consider that regulators do not exist to be liked or to pick sides- they exist to provide regulations and protect consumers.

Given the catastrophic failures that the crypto world has seen over the past year, regulators are indeed right to worry, and see the crypto assets and cryptocurrencies as a potentially destabilising force that needs to be brought under control.

Of course, choosing to research, develop, and release a CBDC, which is sometimes considered the ideological opposite of cryptocurrency, can make it seem like central banks are intent on stamping out this nascent industry.

We can only guess how much of the development of CBDCs is motivated by a malicious desire to clip the crypto industry’s wings, but the truth is that as an industry, the cryptocurrency community has not always done a good job at self-regulation, and regulators are stepping in because there is a genuine risk that cryptocurrency assets pose to economic stability.

Can crypto survive alongside CBDCs?

Seeing as many central banks are already developing CBDCs, and that some have even launched CBDCs, a world where cryptocurrencies must exist and in some sense compete with CBDCs.

Can cryptocurrencies, and cryptocurrencies actually do so?

First of all, CBDCs are not cryptocurrencies. While there may be some overlap in terms of their underlying technology, these two different currencies are fundamentally different products.

A CBDC, whether retail or wholesale or any mix of the two, is essentially a digitalised version of an already existing fiat currency. If people do not have faith in the value of the government’s fiat currency, there is no CBDC that will fix the problem. A CBDC is also not going to attract people who see crypto as a hedge against inflation, since CBDCs will be subject to the same inflation that fiat currencies are.

Cryptocurrencies, on the other hand, are not created by central banks, and are therefore not always subject to the same inflationary pressures as CBDCs. As such, cryptocurrencies may attract people who hope to safeguard their wealth against inflation.

There is also the issue of CBDCs and cryptocurrencies targeting different groups. Privacy-minded individuals may not appreciate the programmability of CBDCs, and instead use cryptocurrencies, since the blockchain technology that underlies these currencies is the one that provides these functions, rather than the tokenomics of the currencies themselves.

On the other hand, those that do not wish to deal with the rapid fluctuations of cryptocurrency prices can simply use CBDCs or stablecoins.

These two products, therefore, are not exactly direct competitors, even though they rely on the same technologies.

On the contrary, there are ways in which cryptocurrencies and cryptocurrencies may actually be able to benefit from the creation of CBDCs.

Why cryptocurrency needs CBDCs

For starters, let us take a look at the process of how new cryptocurrency holders actually get cryptocurrency.

To begin, they often need to sign up for a wallet, and approach a cryptocurrency exchange to exchange fiat currencies for cryptocurrency. This often involves a tedious process of KYC procedures, linking bank accounts, and filling in endless forms.

With CBDCs being on a blockchain, however, this process might be made much simpler. Cryptocurrency exchanges will likely have a much easier time onboarding customers from a permissioned system where holders of CBDCs are already verified and credentialed.

CBDC to crypto transactions from one blockchain to another may also be cheaper than fiat to crypto transactions, since there is a possibility of cutting down on the number of intermediary parties who have to verify, approve, and carry out the transactions.

But the biggest beneficiaries of CBDCs will likely be cryptocurrency companies.

Cryptocurrency prices are volatile, and while during a bull market this means that many people are buying into the cryptocurrency market, and token prices pump to unbelievable levels. But during a bear market this means that everyone is fleeing the space, and it is during this time that token prices crash, and death spirals ensue.

Of course, some of these tokens are not worth saving- they represent projects that offer nothing of value and fail because investors take a closer look at what goes on under the hood and do not like what they see.

But there will also be some projects that simply get caught up in the carnage as collateral damage. These projects would greatly benefit from urgent backing and liquidity injections. If these injections are provided through CBDCs, transfers could be instantaneous, and buy these companies some much-needed time to reassure token holders and stem the bleeding.

Binance founder CZ actually proposed that a fund be created to save such projects in the aftermath of the FTX meltdown, with the the Industry Recovery Initiative. This is, fundamentally, a good idea to preserve projects that show potential and provide utility.

But backing companies with more tokens that are also declining in price and therefore purchasing power is going to be less effective than backing them with fiat currencies that are maintaining their price.

The development of CBDCs, therefore, may not actually be something that is created with the idea of destroying crypto. On the contrary, there might be ways in which the creation of CBDCs actually benefits the crypto industry.

While they might be ideologically different, competition is not necessarily a given. Instead, we should also consider if there are synergies to be unlocked, and opportunities to take advantage of.

Crypto is a nascent industry with enormous potential, and to make enemies of regulators is a counterproductive strategy. Instead, understanding, educating, and cooperating with regulators may create benefits for all- and this is what the industry should do.