The Next Big Disruption To The Crypto Industry (And Nope, It Isn’t Regulation)

The Next Big Disruption To The Crypto Industry (And Nope, It Isn’t Regulation)
Reda Farran, CFA

over 2 years ago5 mins

    • CBDCs can’t be counterfeited, can be tracked, and could be used for various economy-boosting measures – but at the expense of privacy and basic freedoms.
    • CBDCs could hurt payment companies by circumventing them, and banks by depriving them of a cheap source of funding.
    • CBDCs could replace cryptocurrencies if governments push theirs as an alternative, but that crackdown could backfire if users prefer crypto’s anonymity.
  • CBDCs can’t be counterfeited, can be tracked, and could be used for various economy-boosting measures – but at the expense of privacy and basic freedoms.
  • CBDCs could hurt payment companies by circumventing them, and banks by depriving them of a cheap source of funding.
  • CBDCs could replace cryptocurrencies if governments push theirs as an alternative, but that crackdown could backfire if users prefer crypto’s anonymity.

Mentioned in story

With the recent boom in cryptocurrencies, it’s no surprise that governments are exploring digital versions of their own currencies. The result could be a big problem for crypto, fintech companies, big banks, and – if you’re investing in any of them – your portfolio.

💰 What are CBDCs?

A central bank digital currency, or CBDC, is a digital form of a country’s fiat currency: think digital dollars or – as is already being rolled out in China – the digital yuan.

So instead of printing physical money, a central bank would issue electronic coins backed by the full faith and credit of the government. To be clear, this isn’t the same thing as paying with credit cards and payment apps like you do right now. Those are just ways to move money electronically, where a digital currency actually turns money into computer code.

According to the Bank of International Settlements, 90% of the world’s central banks have launched projects on digital currencies. It’s a sign that they’re essentially all fighting for control of their monetary systems: the crypto market is becoming more and more of a challenge to fiat currencies, in turn threatening the tools central bankers rely on to control their economies.

Countries’ different CBDC project stages. Source: Atlantic Council
Countries’ different CBDC project stages. Source: Atlantic Council

👍 What are the benefits of CBDCs?

There are plenty of benefits to CBDCs. They can’t be counterfeited, they make it easier for governments to spot criminal activity, and since they have the same value as their paper versions, they’ll be a lot less volatile than cryptocurrencies. They also allow for instant and cheap money transfers (including cross-border payments) that could boost economic activity, as well as give the two billion unbanked adults access to money transfer services.

What’s more, governments would be able to use CBDCs to quickly implement economy-boosting measures. If, for example, they needed to transfer money to the population like lots of them did during the pandemic, it would be a lot faster and easier if it could be deposited directly into people’s digital wallets.

Last but not least, the money can be programmed. China has tested expiration dates for its digital yuan to encourage users to spend it quickly, for times when the economy needs a jump start. And perhaps even more importantly, the Bank of England has said that its digital pound would allow parents to program their kids’ allowance so they can’t buy candy with it. Phew.

That all sounds great, but therein lies the biggest con of CBDCs: they give unprecedented power to policymakers, allowing them to track people’s spending in real time and keep a record of all money movements in their economies. And that immediately sparks a huge and important debate about privacy and basic freedoms…

🥊 What impact will CBDCs have?

1) Payment companies

CBDCs could completely cut payment companies out of the equation. The digital yuan, for example, is designed to move from A to B instantly, removing the need for private electronic payments systems dominated by Ant Group’s Alipay and Tencent’s WeChat Pay – both of which China is increasingly cracking down on.

Other CBDCs could be designed to work with private payment companies or to replace them altogether. And if it’s the latter, that would be bad news for companies like Square, PayPal, Mastercard, Visa, and Global Payments.

2) Traditional banks

During financial crises, a bank run can happen when many of its clients – worried about the bank’s safety – rush to withdraw their physical money at once. Now imagine those clients, with a touch of a button, could move their money into a completely safe CBDC that’s stored virtually at the central bank. That would make bank runs a lot easier – not great news for the sector.

The central bank could put measures in place to prevent this, mind you – by limiting the amount of CBDC people are allowed to hold, for example. But bank runs aren’t the only issue here: even in good times, customer deposits – an essential source of cheap funding for banks – could still flow out of the system if people simply prefer to hold digital money stored with a central bank. In that scenario, banks would have to look for alternative, potentially more expensive sources of funding, which could dent their profits.

3) Crypto

A digital currency revolution could go in two directions. In the first scenario, regulators increasingly crack down on the crypto market and push their CBDCs as an alternative. In an extreme situation where a country’s entire monetary system converts to a CBDC, the government could ban people outright from using them to buy crypto. That scenario would be bad for both crypto prices and the stocks of companies exposed to the wider crypto market, like Coinbase.

In the second scenario, governments’ push towards CBDCs ends up accidentally boosting the crypto market. For one thing, cryptocurrencies like bitcoin have a limited supply that (in theory) makes them a good story of value. The supply of CBDCs, on the other hand, could constantly be inflated by governments, eroding the digital currencies’ purchasing power.

For another, CBDCs negate one of bitcoin’s major appeals: anonymity for the user. That’s because they’re controlled by the government, whereas cryptocurrencies operate on decentralized systems out of governmental reach. If the push towards CBDCs makes people feel like they’re losing their privacy and basic freedoms, it could actually drive them toward anonymous, decentralized cryptocurrencies.

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