On the heels of President-elect Donald Trump's victory and his vow to transform the U.S. into the 'crypto capital of the world,' digital asset markets surged, sending Bitcoin to an all-time high above $75,000. While Trump's pro-crypto stance has reignited interest in decentralised finance, attention is also turning toward stablecoins and central bank digital currencies (CBDCs). Below, we outline the key features, benefits, and considerations surrounding these innovations in digital currency.
What are central bank digital currencies (CBDCs)?
A central bank digital currency (CBDC) is a form of digital money issued and regulated by a nation’s central bank. Unlike cryptocurrencies, which are decentralised and often highly volatile, a CBDC has a stable value tied directly to the country’s fiat currency. While fiat money—like traditional cash—is no longer backed by physical commodities such as gold, it is guaranteed by the government. Historically, fiat currency existed only as physical money (e.g., coins and banknotes), but technological advances have allowed digital forms, such as bank balances and online payments, to become mainstream.
The Bank of England has announced that, if it were to adopt a CBDC, it would call it the "digital pound", providing a central bank-backed digital option for the public. However, it remains cautious, seeking to balance the potential benefits with concerns around privacy, security, and financial stability. A final decision on the digital pound will not be made before 2025.
Why consider a CBDC?
At the 39th Annual International Banking Seminar in Washington, Andrew Bailey, Governor of the Bank of England, highlighted the increasing necessity of updating payment systems—especially for wholesale and cross-border transactions. A CBDC could improve payment efficiency, enhance financial inclusion, and maintain monetary stability in a rapidly digitising world. Bailey noted that while the UK’s existing payment infrastructure already supports fast and free transfers, CBDCs could introduce new possibilities, such as programmable payments that could automate certain transactions.
What are stablecoins?
Stablecoins are private digital currencies designed to maintain a steady value by linking to real-world assets, usually a stable currency like the US dollar. Unlike money held in traditional bank accounts, stablecoins are typically issued by private entities that hold reserves of the asset they are pegged to, which helps keep the stablecoin’s value consistent. These transactions are stored on a digital ledger, allowing users to exchange stablecoins directly, without traditional banks. Users store stablecoins in digital wallets and can send, receive, or exchange them back into traditional currencies with relative ease.
Unlike cryptocurrencies such as Bitcoin, which operate independently of any centralised entity and fluctuate widely in value, stablecoins are backed by assets that provide a more predictable value. However, stablecoins are not without their own risks, especially concerning the transparency and quality of the assets held in reserve.
Regulatory developments for stablecoins
In a bid to address potential risks, the Bank of England and the Bank for International Settlements (BIS) introduced a tool called Pyxtrial this year. Pyxtrial is designed to help regulators monitor stablecoin reserves and liabilities by aggregating public data from various stablecoins, including Tether, USDC, and Binance USD, into a standardised dashboard. This allows regulators to see a consolidated view of stablecoin reserves without requiring direct access to each custodian’s internal records.
The inconsistent reporting standards among stablecoins remains a regulatory challenge. Discrepancies result in gaps between real-time transactions and reserve reporting, which can pose risks, particularly for stablecoins that may become integral to the broader financial system. Although Pyxtrial does not currently assess the quality of these assets, it categorises them by liquidity and asset type, which may lay a foundation for further tracking, even for tokenised assets like US Treasuries.
Outlook and considerations
Both CBDCs and stablecoins represent significant developments in how we think about money and payments, but they also introduce complexities for regulators, financial institutions
- For CBDCs, central banks will need to balance the potential benefits of financial inclusion, reduced transaction costs, and better payment efficiency with the challenges of privacy, cybersecurity, and the risk of disintermediation for traditional banks.
- For stablecoins, greater regulatory oversight will likely be required to ensure asset transparency, maintain liquidity, and build public trust. Tools like Pyxtrial could play a pivotal role in tracking stablecoin reserves, though the need for consistent and frequent reporting remains a challenge.
Both CBDCs and stablecoins could significantly impact the financial system, transforming everything from daily payments to international remittances. However, these changes will require careful management and collaboration between public and private sectors to mitigate risks and ensure these digital currencies benefit the broader economy while safeguarding financial stability.
