CBDC: a risk for cryptocurrencies?

It’s official, the New York Fed has just created a 12-week pilot project to set up a digital currency. A project in cooperation with the main institutions of the banking network. Can CBDCs Hurt Cryptocurrencies? Here we will address this topic.

What does a CBDC (central bank digital currency) ?

A CBDC is a digital currency created and backed by central banks. As cryptocurrencies have grown in popularity in recent years, central banks have had to update and innovate. One of the main characteristics of a CBDC remains the fact that it is issued, centralized, regulated and controlled by central banks.

CBDCs are inspired by cryptocurrency technology. And the fact that this is decided by large institutions will make it possible for the cryptocurrency universe to become known.

It looks like money on debit or credit cards, so not physical money. However, instead of being controlled by commercial banks, the currency will be centralized and controlled by central banks. The objective of central banks remains the preservation of security and transparency in financial transactions.

On another note, establishing a digital currency allows the government to have more control over the actions of citizens. This is the case of China with its assessment project “social credit” to assess the financial behavior of citizens.

Progress of CBDCs globally

Some countries have been considering this topic for some time, some developed countries are still developing, or in research mode. And other countries have already created their own pilot project for a while, this is the case of China for example.

Pilot projects are designed to test the reliability of the concept.

project, pilot, cbdc, crypto
Source: CBDC Tracker

The difference between CBDC and cryptocurrency

The principle remains similar for both as it is a digital currency, the major difference is whether it is centralized or non-centralized. A CBDC is centralized because it is issued by a central bank with accompanying control and regulation.

A CBDC is simply a more evolved version of fiat money (central bank money). It provides a supposedly more “secure” framework because it is supported by a large institution (our elites). Therefore, it reduces the risk of bankruptcy because it is not a company. It also tries to temporarily address the volatility problem of most cryptocurrencies.

However, since it remains a fiat currency, this means that the central bank can multiply the available supply as much as it wants. Therefore, a CBDC does not answer this problem unlike bitcoin which offers a limited supply of bitcoins.

Cryptocurrency turbulence favors the arrival of CBDC

As you know, we had some turbulence that happened in 2022 in the crypto environment. First, we had the takedown of Terra (Luna), whose founder is still wanted by Interpol. Then we had the bankruptcy of the company Celsius (specialized in loans) and recently the liquidity problems of the FTX platform which has just gone bankrupt. The latter further weakening the crypto ecosystem, because it is considered a popular transactional platform, because it is the most used after Binance. However, FTX client funds were used by another research firm ‘Alemada’ which was owned by the same founder.

We can compare the bankruptcy of FTX with that of “Lehman Brothers” in 2008, but we are not on the same scale in terms of market share. Therefore, the domino effect mainly weakens the crypto industry, but less traditional markets.

The FTX case, a coincidence?

That said, I don’t think it’s a coincidence that the FTX case came out days before the New York Fed pilot. A good majority of central banks are accelerating pilot project processes to take advantage of the turbulence in the crypto environment. The advantage of central banks is that they have the power to weaken some systems. It is what manages the liquidity available or not in our system. And if it reduces the liquidity available in the financial system, it creates more volatility. Therefore, there is nothing like cash flow problems to knock down rogue projects and position themselves as the next solution.

Central banks have been following a restrictive monetary policy for several months, this has reduced the available liquidity in the crypto environment. Consequently, it is in this type of situation that less liquid projects, poor management or less transparent companies can run into liquidity difficulties.

Ponzi schemes and crises

Furthermore, a small anecdote with the Madoff affair, it was in 2008 that the affair broke out during the financial crisis. When all the customers wanted to withdraw their money, they realized that they could not sell because the money was not available. It is thanks to crises that Ponzi schemes collapse. All the injections combined with very low rates during 2020 and 2021 allowed the creation of several projects thanks to the abundance of liquidity. This after it ended in 2022, causing some projects to end.

It is after this that we will be able to see the most solid projects and cryptocurrencies.

CBDCs, no longer a risk to stablecoins?

Initially, the principle of CBDCs is to offer something similar to cryptocurrencies, but under different conditions, because it remains a fiat currency, centralized, regulated and controlled. The other difference is volatility. Most cryptocurrencies are highly volatile, which implies reluctance to make them official currencies. But the advent of stablecoins has put pressure on central banks to launch the project as well.

The very principle of the stablecoin was to provide a digital currency that was more stable, less volatile because it was backed by a safe haven like the US dollar. It’s pretty much the same principle as a CBDC, except it’s not centralized. It is not yet known whether the principle of backing a stablecoin on the US dollar remains a reliable process in the long term. Some projects lack transparency and longevity. And recent events are increasing the reluctance of stablecoin credibility.

Even the digital currency, fiat, remains problematic

A fiat currency even in the form of a digital currency does not solve the problem of unlimited supply. An unlimited supply depreciates the currency over the long term. The currency loses purchasing power, and therefore remains inflationary in the long run. That is why I hold the same opinion about bitcoin and his counterattacking against central banks. It maintains its leading position as long as it remains decentralized, not controlled by an institution or a company. And its biggest advantage remains the limited supply.

Conclusion

Central banks are improving the implementation of a CBDC. They are taking advantage of the turbulence of 2022 to gain credibility and maintain their place as a leading institution. CBDCs should be more influenced by stablecoins because they are more similar. However, the rise of a digital currency will encourage beginners to take an interest in the crypto world. I think it’s mainly bitcoin that will benefit from this because it remains the most liquid at the moment. And the only one that meets the unlimited supply of fiat currency.

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Laetitia Bonaventure's avatar
Laetitia Bonaventure

After working for 7 years in a Canadian bank, including 5 years in a portfolio management team as an analyst, I left my job to fully dedicate myself to the financial markets. My goal here is to democratize financial market information for the Cointribune audience in various aspects, including macro analysis, technical analysis, market analysis…

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