CBDC or Stablecoins: Why Traditional Banks Must Adopt a New and Adaptable Policy

Central Bank Digital Currency (or CBDC) and stablecoins are significant indicators that cryptocurrency is here to stay. While governments issue CBDCs, stablecoins are privately created to aid blockchain development.

While both CBDC and stablecoins are basically the same, the primary distinction is in the issuing authority, which can be centralized or decentralized.

CBDCs, for example, are government-issued and so controlled by a centralized body. Stablecoins, on the other hand, do not operate in the same way. They live on a distributed, decentralized blockchain network.

Unlike other crypto-assets like Bitcoin (BTC), Ethereum (Ether), and Solana (SOL), CBDCs and stablecoins offer a far more stable alternative to fiat currencies. CBDCs, in particular, are equivalent to a nation's fiat currency, except that they run on-chain.

Stablecoins, on the other hand, are encased currencies whose value is tethered to another cryptocurrency, fiat money, or exchange-traded commodity.

We make stablecoins as an example in this context because they are tethered to the value of fiat currencies. For example, a unit of Tether (USDT), USD Coin (USDC), or Binance USD (BUSD) is approximately worth $1, indicating that they function similarly to a digital USD.

Having stated that, how does digitization of financial services, particularly in the area of currency distribution, influence conventional banks and their current policies?

While some traditional banks are active in their approach to widespread cryptocurrency acceptance, the great majority are still just getting started to investigate this business-rising scheme. For example, institutions such as JPMorgan, Goldman Sachs, and Revolut, among others, have either accepted cryptocurrencies as a form of payment or created their own digital coin.

Nevertheless, several banks have yet to register their presence in the crypto realm, while in other cases, governments have made crypto adoption difficult for traditional banks. Nigeria, China, Qatar, Egypt, and Morocco are just a few notable instances.

The globe is rapidly approaching a point when banks either embrace the new crypto business or face significant uncertainty in the ever-changing world of finance.

Ernst & Young (EY) suggested in its most recent global regulatory outlook report that banks alter their regulatory perimeter to accommodate the upcoming debuts of state-backed central bank digital currencies (CBDCs) and private stablecoins.

According to the research, digitalization is having a huge impact on the global financial ecosystem, with one of the most critical sectors being the availability and facilitation of digital money.

While the research does not dismiss worries about consumer protection and money laundering, it does indicate that customers' desire for digital assets may outrun the firm's internal control environment. As a result, it is more critical than ever for traditional banking organizations to re-evaluate their regulatory boundaries.

Another big issue highlighted is that retail banks may lose a significant number of clients if they choose to implement CBDC, which looks to be a safer alternative for people with low or no risk tolerance but are eager to go digital.

"If clients can retain their money with a central bank, they will have no need to use a retail bank, and companies' interest rate margins will collapse dramatically," the paper states.

Additionally, the report discussed the potential impact of the upcoming evolution on traditional retail banking, stating that "the macroprudential or international implications of a major currency having a retail coin could be extremely significant for retail banks and the dollarization of smaller economies."

As a result of the above, it is likely that the majority of central banks will pursue a wholesale version, allowing retail banks to fend for themselves. "Even then, banks must consider the consequences for their balance sheets and the potential interplay between central bank digital assets and private ones, such as stablecoins," the paper added.

With no way out, one would wonder how banks will weather the approaching storm. The best course of action for conventional banks, as advocated by EY, would thus be to adopt proactive measures, particularly in terms of knowing the regulatory landscape.

Additionally to planning for the worst-case scenario, established institutions must seek a seat on the central banking authority and choose the appropriate response to developing tokenomics.