At the Federal Reserve, we will continue to analyze the potential benefits and costs of central bank digital currencies and look forward to learning from other central banks. Moreover, widespread adoption of stablecoins could have implications for the role of central banks and monetary policy. Large-scale migration into a new stablecoin network for purposes of payments may prove to be the leading edge of a broader migration. If a large share of domestic households and businesses come to rely on a global stablecoin not only as a means of payment but also as a store of value, this could shrink demand for physical cash and affect the size Proof of space of the central bank’s balance sheet. The central bank’s approach to implementing monetary policy may be complicated to the extent that banks’ participation in short-term funding markets is affected.

Case studies: Successful regulation of stablecoins

Senate and the Markets in Crypto Assets https://www.xcritical.com/ Regulation (MiCA) proposed in the European Union. As of December 2022, more than 100 countries are working on CBDCs, with major regions like the U.S., Canada, and Europe in the development stage. Tokenization can transform the financial system by making it more efficient, accessible, and transparent.

• A useful starting point then for any discussion of the different implementations of tokenized currencies might be a short definition of the main candidates.
• By potentially facilitating transactions outside the conventional banking system, stablecoins could dilute the effectiveness of monetary policy, necessitating a regulatory framework that aligns with national economic goals.
• As of December 2022, more than 100 countries are working on CBDCs, with major regions like the U.S., Canada, and Europe in the development stage.
• Interoperability with existing financial systems is essential, and so CBDCs are developed to seamlessly integrate with national payment systems and adhere to international financial regulations.

Stablecoins and Central Bank Digital Currency: Challenges and Opportunities

This way, we will have a chance to use the advantages of having both public and private money to solve the longstanding problems of payment inefficiencies and financial inclusion. By contrast, entrenching the status quo and preserving the current regulatory and payment models could cause us to miss an opportunity to address the inefficiencies of the existing system. Wholesale CBDC could also be an enabler for various design and distribution architectures of tokenized money options, such as retail CBDC, CBMT, and CBDC-backed stablecoins issued by commercial banks (see below). In the case that such digital currencies are authorized for use, they will be based on the requirement that commercial banks hold equivalent wholesale CBDC as an alternative to their conventional digital reserve accounts. stablecoin payments Stablecoins, on the other hand, are a type of cryptocurrency designed to maintain a stable value over time, often by being pegged to a fiat currency, a basket of currencies, or other assets. Unlike CBDCs, stablecoins operate on a decentralized infrastructure and are typically not issued by a central bank but by private entities, thereby inheriting characteristics of both traditional currencies and cryptocurrencies.

Demystifying tokenized currencies

Since these currencies are pegged to centrally regulated fiat currencies, Stablecoins are easier for regulators to influence than fully decentralized cryptocurrencies. Kaleido’s CBDC Sandbox makes it easy for central and commercial banks to build fully-custom, wholly-owned CBDC solutions for testing use cases and moving to production—cutting development times and cost by 10x. Their collective development and integration matter not only for the technological and financial communities but also for global economies at large, underscoring the transformative potential of digital finance.

What is a CBDC (Central Bank Digital Currency)?

Generally considered the most effective structure, fiat-collateralized stablecoins are backed by reserves of fiat currency held in bank accounts. Each stablecoin issued is backed by an equivalent amount of fiat currency, ensuring financial stability. Central banks are working to establish clear legal frameworks that define the rights and obligations of all parties involved in stablecoin transactions. This includes safeguarding against fraud, ensuring the privacy and security of transactions, and providing recourse in the event of disputes or failures. By setting high standards for consumer protection, central banks aim to build trust in stablecoins as a reliable and safe means of digital transactions. The ascent of stablecoins in the digital currency landscape presents a compelling narrative, positioning them as a formidable alternative to Central Bank Digital Currencies (CBDCs).

Central bank digital currencies have the potential to “partially” transform economies, making transactions safe, bringing greater transparency and inclusivity to those that have been unbanked. They are controlled by a central authority and can be minted and burned at that authority’s whim. True cryptos are decentralized and controlled by rules that cannot be easily changed. Depending on the CBDC, if they are blockchain-based, they can be stored pseudonymously in a crypto wallet like any other crypto. However, CBDC programs are generally authorized as (private) blockchain-based. Stablecoins are digital assets that purport to maintain a stable value relative to a fiat currency by holding assets (which may be of variable value) as backing.

In addition, central banks can play a critical role as providers of liquidity by lending central bank money at moments of stress. To navigate the potential futures of CBDCs and stablecoins, it’s crucial to understand their diverse designs and uses. The approach to CBDC issuance varies widely across the globe, with different models being explored.

Namely, the Federal Reserve (the “Fed”) sits atop our monetary system, managing the markets through monetary policy tools such as open-market operations, bank reserve requirements, and discount window lending. Within this system, banks “bundle” lending, payments, and deposit-taking in their business models, comply with extensive regulation, and are protected by high regulatory barriers to entry. What makes them safer are the deposit insurance system and a special regime called “resolution” of troubled banks. New forms of digital money, such as privately-issued cryptocurrencies, are well on their way to mainstream use. Another category of this new digital money has piqued the interest of governments around the world. Almost one hundred countries have begun research, development, and trials of digital forms of central bank money, known collectively as Central Bank Digital Currencies (CBDCs).

These stablecoins (and many others) track the price of fiat currency (such as U.S. or Canadian dollars). This makes them attractive cryptocurrencies, especially for cryptocurrency traders who want to lock-in profits without ‘off-ramping’ to fiat currency. However, just because a stablecoin mirrors a price of a particular currency does not mean it is fully backed by an equivalent reserve of that currency in a bank account. In other words, 78 billion USDT does not necessarily mean that the issuer of USDT has US$78 billion in its bank account. Blockchain technology underpinning stablecoins offers unparalleled transparency and security, which are crucial for effective anti-money laundering (AML) measures. Each transaction is recorded on a public ledger, providing an immutable and transparent record of all transactions.

Recognizing the global nature of stablecoins, international efforts have been initiated to establish consistent regulatory frameworks. Organizations like the Financial Stability Board (FSB) and the International Organization of Securities Commissions (IOSCO) are actively working on developing guidelines and recommendations for the regulation of stablecoins. These efforts aim to promote cooperation among countries, facilitate information sharing, and ensure a level playing field for stablecoin operators globally. One option is to require that stablecoin providers hold safe and liquid assets, as well as sufficient equity to protect coin-holders from losses. In essence, the call would be to regulate stablecoin providers despite them not being traditional banks; not an easy task we have found out. Our last blog introduced stablecoins—cryptographic tokens that can be easily exchanged, benefitting from minimal price volatility relative to cash.

This seems timely as several central banks are considering launching a cryptographic currency. The central bank digital currency (CBDC) trend gained traction following the emergence of a number of privately-issued stablecoins. This paper distinguishes amongst thirteen design dimensions that are relevant for decision makers launching stablecoins and central bank digital currencies using distributed ledger technologies. We explain each dimension in the context of prominent CBDC and stablecoin projects.

In May, the US House passed a bill prohibiting the direct issuance of a retail CBDC, but the Senate has not acted. The bottom line is that appropriate regulation may offer a path whereby stablecoins become effectively equivalent to the use of CBDC — when they are issued by regulated institutions and backed by reserves. As adoption continues to grow and innovation flourishes alongside popular cryptocurrencies, stablecoins are set to become a cornerstone of the digital economy, transforming the way we conduct FX transactions for years to come. While stablecoins offer compelling benefits for FX payments, several challenges remain, including regulatory uncertainty, scalability issues, and the need for interoperability between fintechs and the broader financial system.

However, without proper regulation, there are concerns about potential risks such as money laundering, terrorist financing, and market manipulation. By regulating stablecoins, authorities can establish a framework that addresses these risks while still allowing for innovation and competition in the digital currency space. Ever since its inception in 2009, cryptocurrencies have made significant progress, with an estimated 425 million users worldwide as of 2023, according to data from Exploding Topics. Although Bitcoin has yet to gain official acceptance and regulation by major countries, it is viewed as a threat to traditional fiat finance by most central banks. To counter the potential impact on traditional currencies, many countries have introduced the concept of central bank digital currencies (CBDCs). These CBDCs can be observed as cryptocurrencies controlled by the central banks of various nations (see my earlier articles for further information).

Stablecoins also differ from the initial set of cryptocurrencies in that they may be issued by a central entity and rely on third-party institutions for some aspects. In addition, CBDCs may be minted on private ledgers and operated by financial institutions (the current ‘two tier’ model adopted by most proposed CBDCs). On the other hand, stablecoins are issued on public blockchains by a company, which allows individuals to operate nodes and execute smart contracts, lending the utility of stablecoins to DeFi, but without the same protections. One possible regulatory path forward is to give stablecoin providers access to central bank reserves. This also offers a blueprint for how central banks could partner with the private sector to offer the digital cash of tomorrow—called synthetic central bank digital currency (sCBDC)—as discussed in the IMF’s first Fintech Note.