It’s official, the New York Fed has just set up a 12-week pilot project on setting up a digital currency. A project in collaboration with major institutions in the banking network. Can CBDCs harm cryptocurrencies? This is where we are going to tackle the subject.
What does a CBDC (central bank digital currency) ?
A CBDC is a digital currency set up and supported by central banks. With the rise in popularity of cryptocurrencies in recent years, central banks need 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 put in place by large institutions will make it possible to make known the universe of cryptocurrency.
It looks like money like 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 to preserve security and transparency in financial transactions.
In another register, setting up a digital currency allows the government to have more control over the actions of citizens. This is the case of China with its rating project “social credit” to assess the financial behavior of citizens.
The Advancement of CBDCs Globally
Several countries have been looking into the subject for some time, some developed countries are still in development, or in research mode. And other countries have already set up their pilot project for a while, this is the case of China for example.
Pilot projects are set up to test the reliability of the concept.
The difference between CBDC and cryptocurrency
The principle remains similar for both since it is digital currency, the big difference is in the fact of being centralized or not centralized. A CBDC is centralized because it is issued by a central bank with the control and regulation that goes with it.
A CBDC is just a more evolved version of fiat money (central bank money). It offers a supposedly more “safe” framework because it is supported by a major institution (our elites). Therefore, this decreases the risk of bankruptcy because it is not a company. It also tries to temporarily address the volatility problem of the majority of cryptocurrencies.
However, since it remains a fiat currency, this implies that the central bank can multiply the available supply as much as it wants. Therefore, a CBDC does not respond to this problem unlike bitcoin which offers a limited supply of bitcoins.
Cryptocurrency turbulence favors the arrival of the CBDC
As you know, we had several turbulences that occurred in 2022 in the crypto environment. First, we had the crash of Terra (Luna) whose founder is still wanted by Interpol. Then we had the bankruptcy of the company Celsius (specialized in loans) and more recently, the liquidity problems of the FTX platform which has just gone bankrupt. The latter having more deeply weakens the crypto ecosystem because it is considered a popular transactional platform because the most used behind 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 to that of “Lehman Brothers” in 2008 but we are not on the same scale in terms of market weight. Therefore, the domino effect mainly weakens the crypto industry but less so the traditional markets.
The FTX case, a coincidence?
That said, I don’t think it’s a coincidence that the FTX case came out a few days before the New York Fed pilot. A good majority of central banks are speeding up pilot project processes to take advantage of turbulence in the crypto environment. The advantage of central banks is that they have the power to weaken certain systems. It is she who 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 deceptive projects and position yourself as the next solution.
Central banks have been pursuing a restrictive monetary policy for several months, this has reduced the liquidity available in the crypto environment. Consequently, it is in this type of situation that the least liquid projects, the poor management or the least transparent companies can jump with a difficulty of liquidity.
The Ponzi scheme and crises
Moreover, a little 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 cash was not available. It is thus thanks to crises that Ponzi schemes are brought down. 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 having ended in 2022, causing the end of certain projects.
It is precisely after this that we will be able to see the most solid projects and crypto-currencies.
CBDCs, no longer a danger for stablecoins?
Initially, the principle of CBDCs is to offer something similar to crypto-currencies but under different conditions because it remains a fiat, centralized, regulated and controlled currency. The other difference is volatility. The majority of cryptocurrencies are very volatile, which implies the reluctance to make them official currencies. But the arrival of stablecoins has put pressure on central banks to embark on the project as well.
The very principle of the stablecoin was to offer a digital currency that was more stable, less volatile because it was backed by a safe haven such as the US dollar. It’s a bit the same principle as a CBDC except that it is not centralized. It is not yet known whether the principle of backing a stablecoin to 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 reliability.
Even digital, fiat currency remains problematic
A fiat currency even in the form of digital currency does not solve the problem of unlimited supply. An unlimited supply devalues the currency over the long term. The currency loses purchasing power, and therefore remains inflationary in the long term. This is why I maintain the same opinion concerning bitcoin, and its counter-offensive against central banks. It retains its leading position as long as it remains decentralized, not controlled by an institution or a company. And its biggest advantage remains its limited offer.
Conclusion
Central banks are stepping up with the implementation of a CBDC. They are taking advantage of the turbulence of 2022 to gain credibility and keep their place as a major institution. CBDCs should be more impacted by stablecoins because they are more similar. However, the rise of a digital currency will encourage novices 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 for the moment. And the only one that meets the unlimited supply of fiat currency.
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