A stablecoin is a class of digital currency that attempts to offer price stability while offering an additional level of security from being backed by a reserve asset such as a pre-existing currency (e.g. USD) or gold, for example. Designed to dramatically reduce volatility in relation to cryptocurrencies (e.g. Bitcoin or Ethereum), this results in a form of digital money that is better suited to modern business and day-to-day transactions and transfers than other cryptocurrencies.
Indeed, such a combination of traditional-asset stability with digital-asset flexibility has proven to be increasingly popular from investors to businesses alike. The Central Bank digital currency (CBDC) was introduced as the traditional market's answer to the stablecoin phenomena from the cryptocurrency world. A CBDC has credit quality of the central bank which can achieve settlement finality for financial contracts. This can also be achieved by other peer-to-peer services in the marketplace, like Fnality, a new wholesale digital cash payments system to settle tokenized transactions with settlement finality. This particular example has the added benefit of its infrastructure being on DLT (Distributed Ledger Technology) enabling faster implementation and meaning that it can interoperate with other DLT systems. It is anticipated that many digital currencies are likely to be built on DLT systems, with blockchains being the most well-known example of this type of technology. However, there are other technology platforms that central banks can consider.
The use of hybrid information architecture is also being developed on a global scale from Europe to China. As such, digital currency projects have accelerated in the last four years and will only continue to build momentum. Regulators from the traditional banking sector still have a role to play however and are continuing to explore the different questions related to the digital asset processes. The control of Central Banks over CBDC’s is not dissimilar to physical currency, but there are also risks. Decentralized finance could be a big change for governments, therefore central banks and governments need to work together to make regulated digital finance work globally.
John Whelan, MD Digital Assets, Santander CIB said: ‘At Santander CIB we are seeing an increasing interest from our clients in the benefits of stablecoins, blockchain and other digital assets and we are proud to be at the forefront of this innovation in capital markets. We are closely watching both the development of CBDCs and privately issued stablecoins and we expect that they will coexist. We believe that Central Banks and other reguators should work together to ensure that prudent regulations are implemented in order to minimize risk and maximize the opportunities”.
It is becoming increasingly clear that there is the potential for CBDC’s and stablecoins to enhance both wholesale and retail banking. With greater efficiency, increased automation coupled with a variety of DLT and blockchain platforms with unique capabilities, big changes in the plumbinging of the financial markets are anticipated.
In digital securities markets, CBDCs have been demonstrated to work well, and have the advantages of bringing a reduction in settlement risk and the ability to bring atomic settlement to the delivery-vs-payment (DvP) process. This is a good model for the wholesale market that needs to operate on the basis of Central Bank money with no credit risk on the CBDC itself. Through increased automation using DLT, a CBDC system can also avoid settlement risk and trading risks and has the potential to dramatically change Euromarkets.
For retail banking the frequency of transactions is much higher and regulators need to consider any risks around the stability of the economy, including limits on how much digital currency can be issued to any single individual and whether the two-step currency-distribution model (Central Bank to commercial bank to retail user) should be maintained.
Both the wholesale and retail banking sectors have unique needs and as such it is more likely that Central Banks will take a technology agnostic, public/private partnership approach to making the first digital cash available.
There is still more to expect in the development of CBDCs, Stablecoins and blockchain, but the uptake is positive. In April 2021, Santander CIB collaborated with the EIB in launching the first EUR 100m 2-year bond, placed with key market investors, in the market’s first multi‑dealer led, primary issuance of digitally native security tokens using public blockchain technology (i.e. the public Ethereum network). Like the EIB’s role in green bonds or risk free rates, this new digital bond issuance aims to pave the way for other market players to turn to blockchain technology for the issuance of financial securities. Meanwhile in El Salvador, Bitcoin has been recognised as legal tender in a bid to tackle the economic problem for citizens sending money home from abroad, which accounts for up to a fifth of the country’s GDP (more here). To make these transfers, people must pay high transaction costs, meanwhile 70 percent of people are unbanked. At Santander CIB, our blockchain and digital assets experts are exploring the uses of the latest technology, its implementation and regulation, and will continue to push to be at the forefront of capital markets innovation.