The past few years have been characterised by the rise of fintech and blockchain companies.
Cryptocurrency, in particular, has been in the spotlight this year, and not necessarily for the right reasons. June saw the implosion of the Terra-Luna pair, and the resulting chain reaction saw companies like Hodlnaut, Celsius, and Three Arrows Capital collapse as well.
Yet, a rival use of blockchain technology has also been in the spotlight, for much more benign reasons. Indeed, Central Bank Digital Currencies (CBDCs) seem to be the blockchain application of choice for many governments and banks. Cambodia launched a retail CBDC in 2020, and Kazakhstan’s central bank has just recommended a phased CBDC rollout over the next few years.
Most significantly, however, global payments society SWIFT announced in October that its infrastructure could support moving CBDCs and other tokenised assets. The announcement, however, failed to make any mention of similar support for cryptocurrencies. Instead, tokenised assets meant tokenised bonds, assets, and cash.
Evidently, this news does not bode well for cryptocurrency. Given that crypto is promoted by its supporters as a viable alternative to fiat currencies, the decision to integrate CBDCs instead of cryptocurrencies into large scale projects with huge reach is cause for concern.
So does this mean that crypto is losing the battle for adoption to CBDCs, and why is that so?
A cryptocurrency is either stable or volatile, but it cannot be both
Is crypto better suited for investment, or as a medium of exchange?
The answer to this question is complex — it depends on which cryptocurrency you are discussing, and quite possibly, what context. Certainly, a case can be made for both.
Banks and payments companies take transaction fees from merchants, which can drive business owners away from adopting these avenues for receiving payments. Cryptocurrencies with low transaction fees and large block sizes can certainly alleviate this problem.
But for businesses and banks, stability is a prized asset. It guarantees that the token that they accept in exchange for their goods and services will not fluctuate in value too much, and that they can in turn pass it on to someone who is willing to supply them with goods and services in return. As a medium of exchange, stability rather than volatility is preferred.
Yet at the same time, it is also true that the volatility of cryptocurrency prices is valued by those who see crypto as an investment. After all, fortunes have been made by investors who have bought and sold their holdings at the right time.
However, it is difficult for cryptocurrency to be both at the same time. After all, stability might be valued by those who hope to use cryptocurrency as a store of value, but this would not be a welcome trait for those who hope to make it rich by investing in crypto using just small sums of money.
CBDCs, however, do not have this conundrum. As central bank liabilities controlled by central banks themselves, they are simply digitalised forms of fiat currency. For many currencies, functioning as a medium of exchange instead of a mode of investment is already built into how the currency functions.
While cryptocurrencies may claim to be viable modes of payments, and some stablecoins certainly are, the SWIFT update also means that CBDCs may currently have the upper hand in adoption.
After all, why bother with a stablecoin that may or may not be accepted, when banks worldwide are willing to accept CBDCs with no fuss at all?
Is privacy and anonymity really a selling point?
Part of the appeal of cryptocurrencies lies in their anonymity. Wallet addresses, while public, are also anonymous. That is, while transactions on the blockchain are viewable by all, an individual may hold any number of wallets without having to declare their identity.
For businesses and regulators, however, this can prove to be a sticking point. Businesses have to fulfil know-your-customer (KYC) obligations, as well as perform measures to prevent money laundering and terror financing (MLTF). Not knowing your customers can mean that they run afoul of the law, and unpleasant outcomes may ensue when investigators come knocking on the door.
Crypto’s anonymity, while a virtue for some, may be a vice for others. Such a conundrum does not exist for CBDCs.
Since CBDCs are run by central banks, principles and obligations of traditional finance find themselves quite at home within government projects of this sort.
Wholesale CBDCs, in fact, only allow financial institutions to hold CBDCs, meaning that the risk of terror financing or money laundering can be closely monitored.
When the organisation designing the CBDC is the very organisation who works closely with the government, government concerns are much more easily heard and understood. In contrast, delegating the designing of a digital currency to a private organisation dedicated to profit seems foolhardy at best.
The lack of anonymity within such a system forms the basis for such a system. Since there is a common interest in ensuring that KYC and MLTF regulations are followed, integrations of CBDCs into national economies are far more likely and far more favourably looked upon when compared to integrations of cryptocurrencies.
Perhaps a more productive strategy for crypto proponents who value privacy and anonymity to take would be to examine how privacy and anonymity can be preserved while catering to the very real concerns of money laundering and terror financing that governments are eager to solve.
If not, CBDCs can be expected to be the default choice by governments hoping to increase financial inclusion and improve cross-border payments.
Should the crypto industry compete or cooperate?
Evidently, the crypto industry has some way to go before they convince anyone that they are in a position to challenge fiat and CBDCs, especially in developed economies.
In many important respects, they have lost the battle now. A survey by the Bank for International Settlements showed that out of the 81 central banks that they surveyed, 90 per cent of them are creating their own CBDC.
In liberal economics, competition regulates the market — and in the market for tech, governments are a significant customer.
The BIS survey and the SWIFT update show that governments overwhelmingly prefer CBDCs over cryptocurrency as a form of digital currency.
The very same point has been noted by prominent writer Donovan Choy, in his piece on why CBDCs are bad.
In some ways, Choy is right — CBDCs are direct competitors to cryptocurrencies, and widespread adoption of CBDCs could mean that many people see far less utility for cryptocurrency.
As Choy pointed out, CBDCs can indeed be used to further government control. However, technology does not proceed towards an end point — it is always evolving in response to what governments, businesses, and individuals need.
If cryptocurrencies are to replace fiat and CBDCs, they must also prove themselves better than fiat and CBDCs — part of doing so includes fulfilling the functions that fiat and CBDCs do.
Centralised control, regulation, and stability are all part of the package. The most obvious starting point is in changing the reputation of the crypto industry from one where illicit activities are commonplace and evasion of regulation is encouraged.
In this respect, many of the biggest crypto players are already on the right track, and cooperating with regulators instead of trying to circumvent them. Crypto.com has been chasing licences, with recent approvals from France, Singapore, and Brazil. Binance, despite leaving Singapore, has also been seeking licences in countries like France, Bahrain, Dubai, and the United States.
Why? Because in order to compete in the long run, the crypto industry must first, cooperate. It is this cooperation with governments and traditional finance that will legitimise the industry, and bring real use cases for it.
Flushing out money laundering, frauds, rug pulls, and other unethical uses to focus on legitimate business is necessary to ensure the cryptocurrency industry’s future growth.
After all, the cryptocurrency industry brings real value with it — the promise of lower transaction fees, instant settlements, and with stablecoins, a viable store of value.
These are all real issues with fiat currencies that cryptocurrencies can deal with, but as it is, not all governments and businesses are prepared to throw away traditional financial principles for these benefits just yet.
In order for the crypto industry to survive, it must learn to pick its battles and sometimes, it may be necessary to lose the battle to win the war.
While CBDCs seem to have the upper hand for now, cryptocurrency is still far from being relegated to the rubbish pile of history. The way forward, it seems, is not to merely tout how crypto can improve finance and fintech — but how they can achieve the goals of regulators and businesses and still offer more.
Featured Image Credit: Phemex