Born during the 2008 Financial Crisis, Bitcoin represented a clear rejection of central bank policies and a critique of fiat currency. Now, a decade later, central banks are on the verge of stepping in with their own currencies on the blockchain.
Just recently, the European Central Bank (ECB) released a report where it details its extensive work around Central Bank Digital Currencies (CBDCs) – and it is not the only one. According to a survey by the Bank for International Settlements, 70% of central banks are exploring CBCDs.
Although CBCDs overlap with cryptocurrency on a number of fronts and may potentially take away market share from certain crypto assets, they are not the same and as such pose no existential threat to crypto as an asset class. If anything, they signal a strong endorsement of blockchain technology and may give rise to regulatory clarity in the digital assets space.
We do, however, urge investors to keep track of these developments closely and diversify their portfolios accordingly.
The rise of CBDCs
The concept behind digital cash has been around since 1983, but really only saw the light of day with the creation of Bitcoin. In contrast to conventional electronic payment systems (e.g. Visa), blockchain-based systems are accessible to anyone with a smartphone and an Internet connection.
Just like Bitcoin, CBDCs offer a range of benefits, including cost-effectiveness, fast settlement, and financial inclusivity, but as they are supported by Central Banks – and their vast reserves – CBDCs are likely to offer more stability and lower credit risk.
One of the challenges posed by cryptocurrency is that it structurally escapes monetary policy and falls outside of existing regulatory perimeters, making it difficult to monitor and manage capital flows. Alongside improved regulation, CBCDs arguably constitute a more radical attempt by the banking world to take back control over the future of money in the digital era.
This leads some commentators to perceive CBDCs as potentially spelling the end of crypto, but such a view fails to see that there is more to crypto than payments alone.
The future of crypto
If CBDCs offer a better alternative to cryptocurrency as a medium of exchange, we may see Bitcoin and similar currencies lose part of their market share – some investors may divert their capital to CBCDs, while others may favor privacy coins such as Monero or Dash.
At the same time, we should not forget that established coins such as Bitcoin are also part of a sub-culture and may retain much of their value simply by virtue of what they represent to an investment community.
But even if CBDCs pose a challenge to payment-oriented cryptocurrencies, at the same time their adoption also signals a strong endorsement of the underlying technology which may further draw positive attention to the crypto space.
What’s more, as central banks become involved, we can expect increased regulatory clarity which would facilitate institutional participation as well.
Beyond that, it’s also good to bear in mind that different cryptocurrencies offer different use cases which should be of continued interest to investors. Ethereum (ETH), for example, stands at the heart of the decentralized finance (DeFi) movement, with ETH deriving part of its value from innovative solutions across lending, trading, borrowing, insurance, payments, and other DeFi-tools. In other words, depending on their utility, not all cryptocurrencies would be equally affected by CBDCs.
Exactly how this will all play out, we cannot predict. But it is highly likely that the rise of CBDCs will rattle the markets. This is why we would urge investors to become extra critical in their appraisal of the various crypto assets and diversify their crypto portfolios accordingly.