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Stablecoin adoption facing a hurdle: Currency substitution – expert insights

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During the WEF’s Annual Meeting of the New Champions in China, Professor Eswar Prasad, author of “The Future of Money: How the Digital Revolution Is Transforming Currencies and Finance,” shed light on central banks’ cautious approach to stablecoins. He specifically highlighted their concern about potential currency substitution, particularly with stablecoins pegged to the U.S. dollar, such as USDC and USDT.

Stablecoins are a unique type of cryptocurrency designed to maintain a consistent value relative to a specific asset or portfolio of assets. Unlike the volatility often associated with cryptocurrencies like Bitcoin or Ethereum, stablecoins aim to provide stability and reduce price fluctuations.

Stablecoins maintain stability through different mechanisms. They can be categorized into several types: fiat-backed stablecoins, commodity-backed stablecoins, crypto-collateralized stablecoins, and algorithmic stablecoins. Fiat-backed stablecoins are supported by reserves of traditional fiat currency, while commodity-backed stablecoins are pegged to the values of physical assets.

Crypto-collateralized stablecoins are backed by other cryptocurrencies, while algorithmic stablecoins utilize algorithms and smart contracts to ensure price stability. These algorithmic stablecoins adjust their supply based on market demand and supply dynamics.

The author observes that digital money is becoming more prevalent globally, primarily driven by its convenience and potential for financial inclusion, especially in developing economies.

However, he also raised concerns about stablecoins potentially causing citizens to replace their local currencies with an asset that is not under the control of the central government. This is one of the factors contributing to the increased development and implementation of Central Bank Digital Currencies (CBDCs) over time.

The use of CBDCs in more nations

The speaker acknowledged that in countries such as China, Sweden, India, Brazil, and Japan, where the current retail payment systems are efficient, the need for retail CBDCs may be less pronounced.

The private sector already provides effective payment transaction options, which raises questions about the necessity of CBDCs for expanding financial inclusion.

However, the professor highlighted some motivations behind CBDCs. For instance, in China, where different payment systems lack direct communication, a CBDC could enable interoperability. Additionally, CBDCs could strengthen payment system resilience and contribute to maintaining monetary sovereignty.

The speaker made a suggestion regarding the use of retail CBDCs, acknowledging that it may be subject to debate. However, they emphasized a stronger case for wholesale CBDCs, emphasizing their potential to facilitate efficient cross-border payments, reduce costs, improve tracking, and benefit trade and financial transactions.

Additionally, the Professor highlighted the risks associated with CBDCs, particularly for smaller countries or those with less credible currencies. They expressed concerns about the stability and credibility of local currencies in light of the availability of stablecoins or widely accessible digital currencies like the digital Renminbi or digital dollar.

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