Crypto – Stablecoins – CBDCs: What’s the difference?

Do you like my handmade chart? I drew it using my 6 year old’s markers. Knew they’d come in handy someday.

Lots of news this year around crypto (it’s a winter, haven’t you heard?), stablecoins (are we going to trust another stablecoin again?) and central bank digital currencies (eCNY, eHKD and yes, Britcoin, here we come!)

How should the average person consider these?

Stablecoins are a type of cryptoasset, whose value is pegged to another asset, typically a fiat currency like the US Dollar. Think of them like an exchange traded fund (ETF) – they track the performance of an underlying asset class. We’ve even seen some stablecoins that track the price of gold.

Central bank digital currencies are exactly what the name suggests. They are a digital asset issued by a central bank as officially mandated currency.

So we’ve seen the journey over time of digital assets as follows:

Crypto ---> Stablecoin ---> Central Bank Digital Currency

Why has this progression taken place?

First, stability. Many investors in crypto got rich quickly, especially the early adopters. Equally, many speculators lost lots of money trying to get rich. The high levels of volatility (large swings of 20% or more per day are not uncommon) make it unlikely cryptocurrencies can be seen as good stores of value, or even reliable investments within a traditional investment framework (e.g. modern portfolio theory, Markowitz framework).

To improve stability, stablecoins that track an underlying asset class provide some market security. A stablecoin linked to the US Dollar or Gold sounds great, right? Unfortunately, it's not that simple. One needs to trust that the arrangers of the stablecoin are indeed linking it efficiently and honourably with its underlying asset class. This wasn't the case with Terra USD, a stablecoin meant to track the US Dollar, as the chart below shows.

Chart: Not all stablecoins are stable

Hence, a stablecoin holder is taking on underlying credit risk. The same way an ETF investor is trusting the provider to appropriately match its exposure.

A central bank digital currency (CBDC) provides stability from a market and credit risk perspective. It’s a currency issued by a central bank. This means it is legal tender and offers underlying sovereign credit risk.

Second, innovation. Cryptoassets and its underlying tech (blockchain, distributed ledger technology) are an incredible innovation, even if we have seen fraud and scandals. It’s no surprise that this innovation originated from private individuals and continues to be driven by the private sector, broadly speaking.

Many governments have adopted a wait and see approach to observe the benefits (and risks) or adopting this new tech.

In 2023, we are witnessing a progression of more and more governments exploring and indicating openness towards digital assets. Hence, the recent CBDC interest and experiments (China, Hong Kong, UK) alongside digital assets regulation (Middle East, Hong Kong, Singapore, UK, Switzerland).

What does this all mean for the average person?

The good news is the consumer will have a lot more choice soon. Some markets will regulate cryptoassets, making them more accessible in a safer way for consumers.

Some markets will introduce CBDCs which offer the technical benefits of a cryptoasset without the corresponding market and credit risks.

Innovation will continue meaning new types of digital assets, maybe linked to traditional investments like gold and real estate, might move to the mainstream.

Which ones will be better? Scandals and fraud aside, no one type of digital asset is better than the other. It comes down to your use case and which digital asset is more appropriate for that.

One thing is for sure: the tech is maturing quickly and regulation is becoming more developed.

This sets the scene for greater adoption of digital assets, regardless of which ones you choose to access.