The digital money landscape
Since the birth of Bitcoin and its vision of censor-ship free digital cash, the universe of different forms of digital money has been slowly but surely evolving. As we know, the formal definition of money has 3 criteria:
· a unit of account
· a store of value
· a medium of exchange.
Whilst many argue as to whether Bitcoin (or more broadly, cryptoassets) meet these criteria, the latest forms of digital money clearly do. Let’s look at these briefly in turn.
The different forms of digital money
Stablecoins burst into the digital world with the initial launch of BitUSD and NuBits in 2014, backed by cryptoassets rather than fiat, and were quickly followed by Tether (USDC), a fiat-backed stablecoin which has grown to be the largest stablecoin in terms of market cap ($84bn at the time of writing). This was followed by the launch by Circle of USDC in 2018, currently 2nd largest with some $26Bn marketcap. There are many other stablecoins of different types and sizes. Fiat-backed stablecoins have reserves held in cash, bonds and other financial instruments.
· central bank digital currency or CBDC
CBDCs are essentially central bank money issued in digital form (as opposed to the physical form of cash). The People’s Bank of China started their ECNY journey in 2017 with pilots starting in April 2020. Nigeria, Bahamas and other countries have since launched a CBDC in production.
· tokenised bank deposits
The third type of digital money we will consider ate tokenized bank deposits, essentially tokenizing the accounts held at a commercial bank. These are distinct from stablecoins as they are subject to the same fractional reserve model and associated regulations as regular bank deposits. The most famous example is the JPM coin, which was launched by the Onyx division of JP Morgan in March 2020.
The adoption of digital money has historically been in part driven by continuing innovation and development of the crypto market, and the corresponding, increasingly focused, actions from regulators and central banks.
Initially fuelled as a convenient way of managing fiat positions during crypto trading, stablecoins are beginning to be used in new ways. For example, Stripe and Checkout.com now support payments to merchants in stablecoins (USDC in this case), and more recently Visa is working with merchant acquirers Worldpay and Nuvei to also accept USDC, meaning that settlements to the merchant can happen much faster.
Stablecoin market cap at the time of writing is approximately $124billion
The graphic below demonstrates the advances being made by stablecoins as a payment mechanism.
With these examples and others, we can see that stablecoins are increasing the utility they offer, although they are also facing increasing regulatory obligations with MiCA in the EU, and similar regulations in other major economies.
CBDCs face a challenge - primarily in the incremental utility they provide over existing, commercial bank money-based faster payments and other mechanisms, together with satisfying public concerns on privacy. Early examples of CBDC adoption have frequently been disappointing as shown in the diagram below from the Breughel Institute.
Central banks face a challenge in developing unique use cases for CBDC to drive adoption whilst not being so successful that commercial banks are disintermediated or that the “singleness of money” is impacted by fragmentation in the monetary system. Whilst the ECB has now moved into a “Preparation Phase” for its next step in the Digital Euro journey, and the Bank of England moves forward with more PoCs and pilots following Project Rosalind, the key question of what will drive successful CBDC adoption is still wide open.
We should also note that there is a wholesale flavour of CBDC, relevant for PvP and DvP applications in wholesale markets but which we will not cover in this discussion.
Tokenised bank deposits
This brings us to the 3rd form of digital money we will review - the tokenization of commercial bank deposits. On the surface, this is a simple idea, tokenizing the fiat that sits in a bank account so that it can be used on a blockchain thus enabling payments 24x7 at low cost and low latency unlike the hours or days that it can take conventionally, and with the constraint of bank opening hours. We should note that tokenized deposits can happen in 2 ways; one where the token is simply a representation of the funds in a bank account which remain the prime, or two when the token is digitally native and is the primary fiat. Most tokenized deposits live on private permissioned chains. However, there is an immediate challenge with this model, in that the tokenized deposits issued by individual commercial banks, can only be used in the network operated by the commercial bank, ie today there is no interbank settlement capability for such tokens. This means that the evolutions of tokenized deposits are in effect creating islands of bank issued tokens with no interoperability between them. This in part has led to the BIS and others to make the case for a Unified Ledger, i.e., a shared ledger capable of supporting both tokenized bank deposits and CBDC - and potentially regulated stablecoins. There are multiple industry efforts to facilitate such a unified ledger, and to overcome the risk of fragmentation of central bank and commercial bank money e.g. Mastercard’s Multi Token Network and the Regulated Liability Network.
Looking to the future
As we pull these three threads of different forms of digital money, how might the evolution happen in practice? There are a number of factors to consider in such an analysis:
· the impact of regulation on stablecoins - specifically, the impact of reserve composition (more liquid less, risky reserves reduce issuer income), demonstrable operational resilience for redemptions at a time of stress, the need for a bank license etc.).
· the further adoption of stablecoin in non-crypto use cases.
· the progression of CBDC deployment, especially given questions of political will, privacy concerns, commercial bank disintermediation concerns, and public skepticism.
· the inertia to overcome to build practical universal ledger implementations.
The uncertainty that exists has prompted the Cambridge Centre for Alternative Finance (CCAF) to develop a Digital Money Dashboard. CCAF’s research programme is funded by 16 public and private institutions who are overseeing this development. Alongside education content of different forms of digital money, the initial focus is on stablecoins, with graphical representations of their market cap, velocity, depegging history, reserve composition, geographical flows and licenses held. Watch this space for the first MVP of the dashboard later this year.