It will not be cryptocurrencies or central bank digital coins that will revolutionize global finance, but rather bank-issued deposit tokens that have many of the benefits of both, writes Igor Pejic, author of Big Tech in Finance. .
Kevin George/Photoria
Fintech experts agree on two things. First, blockchain technology has the potential to transform the financial sector. Second, it’s not cryptocurrencies that do that. Thus, in recent years, the idea of central banks issuing digital fiat currencies, or central bank digital currencies, has gained traction and started to look increasingly inevitable. CBDC trackers like the Atlantic Council show that countries accounting for 98% of global GDP are considering CBDCs. In particular, the success of China’s digital yuan trial has prompted the Federal Reserve, the European Central Bank, and the Bank of England to race toward blockchain-based fiat currencies.
However, in May of this year, the US House of Representatives took the first step toward potentially unraveling the CBDC story. With bipartisan support, we passed legislation that would ban the Federal Reserve from issuing digital dollars. The bill still needs to pass the Senate and be signed by the president, but it’s now hard to imagine how a Fed-issued CBDC will materialize anytime soon. Does this mean that the United States will fall behind in technological innovation, thereby putting the dollar’s global dominance at risk?
Fortunately, private sector alternatives have emerged and even promise to ameliorate the major shortcomings of CBDCs. That’s a deposit token. And American banks are leading the way.
Deposit tokens are privately issued stablecoins, i.e. blockchain-based tokens whose value is tied to the US dollar. However, unlike stablecoins such as Tether or USDC, deposit tokens are not simply created by private companies, but are tied directly to deposits held at licensed banks. By leveraging existing banking infrastructure, deposit tokens benefit from an integrated risk management framework and may even be eligible for deposit insurance.
Deposit tokens have several advantages over traditional commercial bank money, which accounts for more than 90% of the money in circulation today. There are two key differentiators.
The first is instant payments, a quantum leap over the days or even weeks that currently prevail in international transactions. This is made possible through the simultaneous exchange of assets and money (known as atomic payments), speeding up many types of transactions such as cross-border payments and reducing the significant costs associated with them.
The second advantage of deposit tokens is their programmability. Thanks to blockchain’s smart contract capabilities, tokens can be instructed to perform specific actions when certain conditions are met. In other words, banks can set up if-then scenarios on a tamper-proof and uncorruptible ledger, making processes highly automated.
In its promise and centralized setup, deposit tokens are very similar to CBDCs. The big difference is the publisher. Deposit tokens are on the balance sheets of commercial banks and CBDCs are on the balance sheets of central banks. Therefore, CBDCs are actually safer for users as there is zero risk of default. Another benefit of a CBDC is that economy-wide interoperability can be mandated by law. So why bother using deposit tokens?
First, there is a practical argument. That means deposit tokens can be deployed and scaled much faster than CBDCs. CBDCs will not be operational in large Western economies by 2030. After the vote in the House of Commons, it is increasingly likely that there will never be a CBDC.
Then there’s the ideological argument. Since the advent of blockchain, all innovation has been driven by the private sector. Central banks’ entry into this field would build on these private pioneers, but would also severely impede further innovation. Private companies cannot fail commercially and will compete with actors who have the power to regulate them. This is by no means an efficient market.
Furthermore, there are significant contradictions embedded in the very concept of CBDC. If they become too popular, they can create a liquidity shock in the banking system. If people moved even some of their deposits from commercial banks to the Fed’s balance sheet, commercial banks would be forced to reduce lending and become more vulnerable to scenarios like a bank run.
Finally, there are data privacy concerns. Despite proposals such as anonymity vouchers, user trust in CBDCs is catastrophically low. Privacy works much better under private sector solutions. On the other hand, commercial bank customers have other options if their data is misused. And secondly, because there is an independent authority that can impose fines on private actors and revoke their operating licenses. Central banks are not like that.
So it’s no wonder that traditional financial giants are leading the way. Like many other blockchain applications, JPMorgan Chase is at the forefront of deposit tokens. America’s largest bank already introduced JPM Coin for its institutional customers in February 2019. I then joined Project Guardian, a collaboration with the Monetary Authority of Singapore. The project successfully used deposit tokens as a payment mechanism for currency transactions between Singapore and the Japanese Yen, demonstrating the potential for cross-border payments, asset purchases, and automated market making.
Citi piloted Citi Token Services for institutional clients to increase efficiency in cross-border payments, liquidity management, and trade finance. Deposit tokens are clearly considered to be the foundation for further digital asset solutions, essentially building the rails for tokenizing all kinds of real-world assets.
In essence, deposit tokens bridge the gap between the innovative world of digital currencies and the established trust of the traditional banking system. With a clear regulatory framework, integrated risk management, and the possibility of deposit insurance, deposit tokens share more with CBDCs than cryptocurrencies or private stablecoins, but they do not suffer from the same issues. there is no. It is therefore very welcome that American banks are leading the way in private financial innovation.
