Fiat vs Bitcoin: Will CBDC Kill Cryptocurrencies?

​Recently, the Bank for International Settlements (BIS) released the results of a survey for 81 Central Banks about their engagement in Central Bank Digital Currencies (CBDCs). The latest responses showed that the Covid-19 pandemic, stable coins, and emergence of other cryptocurrencies have accelerated the study on CBDCs. More than two thirds of central banks are likely to issue a retail CBDC in the short or medium term. In the eyes of central banks in developed economies, ensuring financial stability is the driving force for developing CBDCs.

Specifically, central banks' development of CBDCs is mainly driven by "payment efficiency", "payment safety", and "financial stability", among which "financial stability" has gained more importance since 2018. This might result from rising concerns of the regulatory authority over systemic risks brought about by cryptocurrencies, according to BIS.

Over 70% of central banks engaged in some form of CBDC work are considering a two-tiered model. Activities where many central banks see a potential role for the private sector include, in particular, the onboarding of clients (including the performance of know-your-customer (KYC) processes and anti-money laundering/combating the financing of terrorism (AML/CFT) procedures), as well as the handling of retail payment.

In addition, many economic policymakers are now considering whether central banks should issue their own digital currencies, to be made available to everyone, rather than just to licensed commercial banks. CBDCs are making headway. Should this kill cryptocurrencies?

CBDC vs Crypto

CBDCs are completely different from cryptocurrencies. In essence, CBDCs are the digital form of a country's fiat currency, which is issued and regulated by a nation's monetary authority or central bank. They are pegged to the value of that country's fiat currency. For example. China's eCNY offers an alternative payment rail that's a replacement for cash, or M0.

On the other hand, cryptocurrencies are an encrypted data string that denotes a unit of currency. It is monitored and organized by a peer-to-peer network, i.e. blockchain, which also serves as a secure ledger of transactions. Cryptocurrencies are not regulated by any national monetary or financial authority, as they are not officially accepted by most countries.

With stable foreign exchange rate, CBDCs are easy to manage and are widely accepted in the global market. On the contrary, cryptocurrencies are volatile, which is taken more as an asset for investment instead of a fiat.

Why Are CBDCs Issued?

Cryptocurrencies emerged years earlier than CBDCs. Even now, only few countries have established laws and regulations governing cryptocurrencies.

From the perspective of a central bank, cryptocurrencies are not welcome at all when a huge number of investors abandon fiat and embrace another virtual assets. In the crypto world, every one can issue a coin, as long as the technology is put in place, which does not make any sense and will never happen in the real world. Crypto investors welcome this idea and flock to issue their own coins, and some of them make a bumper profit from it, such as the issuing of Shitcoin and Dogecoin.

In another sense, cryptocurrencies are extremely scarce with uneven distribution. Whale Alear's data showed that 6,713 bitcoins were transfered tto Xapo from a wallet on June 29, 2021, totaling 230 million US dollars. According to statistics released by Santiment in mid July 2021, Bitcoin whale addresses holding between 100 and 10,000 coins owned 9.13 million coins, reaching approximately 49% of the total supply.

Central Banks will never allow a currency to challenge its fiat's legality. Maybe this is a major reason why they scramble to engage in CBDCs.

Libra, Destined to Fail

Libra Coin is the one that came to closest to challenging USD, and the result could be expected at the very beginning at its birth, though it's reported that Libra's failure came after regulatory pushback.

As stated in FB's whitepaper, Libra coin is a permissioned blockchain-based stablecoin payment system proposed by the American social media company Meta Platforms. The plan also includes a private currency implemented as a cryptocurrency.

Libra is operated in a way similar to Bitcoin. Based on digital encryption and de-centralized payment system, scarcity, anonymity and security at every link of circulation are guaranteed.

Libra can be exchanged from and to cash for online transactions, the same as Bitcoin. Nevertheless, there's a difference: Libra coins target FB users, which makes it relatively stable; while Bitcoin targets a global audience.

FB claimed that a simple cross-border currency system will be established to serve its 2.7 billion users, with an estimated payment amount reaching 700 billion USD, rivaling the FED and IMF. As Libra is not issued by a sovereign organ, it is only considered a token instead of a fiat in a stricter sense.

Such that, the organization has super sovereignty with authority to issue currency, which is a paramount legal power of a sovereign country. Circulation of Libra will arise doubts over sovereign countries' legality in issuing currency. What's more, when a "currency" is endorsed by the huge assets and reputation of tech giants rather than a sovereign country's credit, which means the giant, as the currency issuer, has control over the token, it makes Central Banks nervous: Libra is challenging the foundation of the US and dollars.

Don't you think it's familiar? Let's go back to 1944, when the US dollar was set pegged to gold with the approval of 44 heads of state in the Bretton Woods system. 28 years later, when the greenback was dominant in the global market, Nixon, the US president then, decided to abolish the Bretton Woods system and start to print as many bank notes as Americans want!

If Libra became a stable coin that is pegged to a basket of multiple currencies, the US Congress cannot stop it. Within 10 years, over 3 billion people will get used to this new currency across the globe. Then Mark Zuckerberg can simply announce that he abandons the stable coin system and Libra value should be determined by demand and supply in the market. Again, the world will witness the birth of a new "dollar".

Do you think the US Congress will approve the same trick that they did decades ago?

It can be reckoned that Central Banks flock to develop CBDCs because they feel the potential threat of cryptocurrencies. If the risk continues, just like what we have seen in Zimbabwe and Venezuela, will you resort to Bitcoin or local currency? In the final analysis, it is confidence and credit that determine the value of a currency. A fiat can be destroyed as long as the market shows higher preference to or confidence on cryptocurrencies.  

With Volatility Comes Profit

As mentioned above, people embrace cryptocurrencies because they are seeking rapid and huge gains. Luna's sharp decline does blow out many long accounts, but also creates many millionaires for short sellers. Some investors still chose to go long with Luna at the trough in hope of re-bounce in the future.

Even cryptocurrencies cannot make itself a general equivalent, it is still an attractive investment instrument as it has larger volatility than any other assets such as bonds, stocks, forex, futures, crude oil, and options. As the proverb goes, he who is greedy is always in want. Every investor would assume they can grasp the best opportunity for entry and exit at the most appropriate time for the largest possible earnings.

But this logic would never apply to CBDCs. As a digital form of fiat, CBDCs do not intend to gain any profits from market movement.

Summary

CBDCs will not kill cryptocurrencies, as CBDCs are a digital form of fiat, and cryptocurrencies are more of an investment asset. Though facing challenges and difficulties, cryptocurrencies will finally be favored by a growing number of investors.