What CBDCs mean for the future of DeFi and Stablecoins


Over the past year, the narrative surrounding central bank digital currencies (CBDCs) has advanced significantly. From an almost entirely conceptual discussion, CBDCs are now in various stages of research and development to determine how they might work in practice.

The Chinese digital yuan is currently leading the pack. After several pilot projects, the Chinese government is expected to deploy its CBDC to a population of over one billion people by 2022. Although no other country has yet reached the same stage of CBDC development, surprisingly progress has been made. rapid were made. Recently, the G7 chiefs of finance met and reached consensus on some principles defining CBDCs. But outside of China, some of the most significant results have also appeared in Asian countries.

Charles d’Haussy is Managing Director of ConsenSys based in Hong Kong. This editorial is part of CoinDesk “Politics week” a forum to discuss how regulators view crypto (and vice versa).

Particularly noteworthy are the efforts of the Hong Kong Monetary Authority (HKMA) and its collaborative efforts. Since 2017, the HKMA has been studying the idea of ​​a CBDC. First, called Project LionRock, he studied the concept of a so-called “wholesale” CBDC, a digital currency for settlement between banks.

In 2019, she partnered with the Bank of Thailand to study CBDCs for cross-border payment. After the involvement of the Central Bank of the United Arab Emirates, the Digital Currency Institute of the People’s Bank of China and the Bank for International Settlements (BIS), the collaboration entered a new phase to develop a multiple CBDC bridge, dubbed mBridge.

However, the most recent development is the one that could have the biggest impact on the status quo. In particular, CBDCs are an existential threat to unlicensed finance that crypto has become accustomed to.

An invitation to consult on a retail CBDC

In early October, the HKMA released a CBDC white paper, calling for input from experts in monetary policy, banking, and distributed ledger technology regarding the prospect of an electronic Hong Kong dollar (e-HKD).

The document asks many questions, such as the distribution of monetary responsibility between central banks and the financial sector. But for those of us in the blockchain and cryptocurrency community, there is a lot more to chew on.

Read more: Hong Kong Monetary Authority Releases CBDC White Paper to Study Outlook for e-HKD

While the paper is agnostic about the technological infrastructure needed for a CBDC, it invites consultation on seven “problem statements”. These are privacy, interoperability, scalability and performance, cybersecurity, compliance, operational robustness and resiliency, and the technological functional capabilities offered by a retail CBDC. .

A familiar set of puzzles

Any business or organization that has considered implementing blockchain or decentralized ledger technology has faced some or all of these questions. Ultimately, they boil down to this: Do the advantages of an unlicensed, open, decentralized public network like Ethereum outweigh the disadvantages? Or would an authorized implementation be a better option?

In the context of CBDCs, there are far-reaching implications in choosing between authorized and unauthorized registries. Providing an adequate solution to one of the problem statements inevitably creates problems in another.

For example, we could make the safe assumption that a central bank would not want a CBDC to offer the same level of pseudonym as a cryptocurrency like BTC or ETH and would seize the opportunity to incorporate measures based on conformance in architecture. Requiring a user to go through Know Your Customer (KYC) and Anti-Money Laundering (AML) checks to open an account is an obvious example.

But in turn, the introduction of identity checks generates legitimate questions regarding government oversight and user privacy, which must be balanced against the need to consider financial law enforcement and privacy. prevent CBDCs from being used in criminal activities.

Strength in numbers

There is a similar trade-off to balance operational robustness and resiliency with cybersecurity. Unauthorized blockchains such as Ethereum and Bitcoin have proven for many years to be robust against attacks, thanks to the size of their networks. Nature without permission encourages participation and creates a highly resilient architecture that is prohibitively expensive to attack.

However, from the point of view of the CBDC, there are downsides, most importantly, a lack of control over performance and scalability. The process of upgrading public blockchain networks can also be prolonged, especially when it requires the consensus of a majority of participants in a decentralized network.

There are arguments for and against chain governance, but it seems unlikely that a central bank would want to cede full control of the governance of the national currency to a decentralized network, even if it could somehow verify. another that all the participants in the network were honest and that the monitoring time was limited.

Ultimately, it seems likely that an authorized implementation of a certain description could prevail. However, central banks will need to address privacy and security concerns without compromising their need for compliance, control and performance.

A tough future for stablecoins

One missing aspect of the HKMA paper, and indeed of the CBDC debate in general, is the opportunities in decentralized finance (DeFi). DeFi emerged and evolved due to the specific characteristics and advantages inherent in cryptography; for example, the ability to create programmable money with automated transactions governed by smart contracts. Traders can take advantage of in-the-moment arbitrage and settle payments of any value almost instantly, 24 hours a day, 7 days a week, from anywhere in the world. As such, CBDCs offer real transformative potential to the broader global asset markets.

However, this raises many difficult questions about the future of stablecoins. As the value of the crypto and DeFi markets has risen and institutional interest grows week to week, regulators are increasingly vocal in calling for caution. The chairman of the United States Securities and Exchange Commission, Gary Gensler, recently called stablecoins “poker chips” and it seems that some sort of legislation governing digital dollar equivalents may be a matter of time.

See also: Federal Reserve Governor Quarles doesn’t see the reasoning behind CBDCs

This is an issue that is becoming increasingly important to lawyers, analysts and consultants across the spectrum of crypto, finance and technology. McKinsey recently released his own take on the situation, stating that while regulated stablecoins can coexist with CBDCs, it is just as plausible that one trumps the other.

An unfair advantage?

It should be noted that CBDCs have two distinct advantages over stablecoins from the start. First, as noted earlier, CBDCs provide the ability to integrate compliance and digital identity functionality from the start. In contrast, stablecoins such as tether (USDT), issued on multiple blockchains, operate within the limits of the platform’s rules.

In its current format, Tether couldn’t unilaterally insist on KYC checks to use USDT. However, such a feature would reduce the compliance burden and costs for financial institutions, which can swallow up to 5% of bank revenues.

Second, CBDCs could also automate tax collection and distribution, reducing another headache for banks. In many jurisdictions, such as Switzerland, banks withhold tax on certain transactions, such as those of foreign residents. In all countries, banks are required to comply with authorities’ disclosure orders in the event of tax evasion.

In light of these advantages, given the choice between CBDCs and regulated stablecoins, CBDCs would be a given to virtually any financial institution.

The many dilemmas surrounding launching a retail CBDC mean it could still be several years before the real impact becomes clear. However, it is already evident that CBDCs will bring substantial opportunities to the financial system, but could ultimately pose an existential threat to stablecoins and the current DeFi landscape.


About Emilie Brandow

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