Volatility, which has refused to leave the digital currency world, is a product of apprehensions. To this day, neither governments (except El Salvador) nor central banks and other regulators consider digital currencies a medium of exchange, despite the promising blockchain tech that underpins the space. But at least three recent developments point towards an impending shift in this ecosystem.
The first shift can be triggered by Diem stablecoins, a project backed by Facebook.
Decoupling of stablecoins from cryptoassets
On June 11, the Basel Committee on Banking Supervision proposed banks make provisions for any losses incurred on cryptoassets holdings. The proposal made a clear distinction between cryptoassets like bitcoin and stablecoins.
The panel proposed an enormous 1,250 per cent risk-weightage for bitcoin and other cryptocurrencies that carry “unique risks”. However, for stablecoins, existing requirements for bank assets like loans and bonds apply. Going forth, banks with exposure to bitcoin and other blockchain-based cryptoassets may need to set aside capital similar to the value of exposure.
On May 24, Atlanta Federal Reserve President Raphael Bostic voiced concerns about the volatility in the crypto space but sounded optimistic about stablecoins. He claims the latter is comparatively closer to fiat currencies but still a work-in-progress. The view came alongside Federal Reserve Governor Lael Brainard’s statement on the Fed developing a central bank digital currency (CBDC) in the light of the ‘threat’ stablecoins may create. The governor was wary of private money bringing new risks to financial stability.
Almost a week before this, the Bank of Canada flagged the risks posed by volatility in cryptoassets to Canada’s financial landscape. The highlight was the central bank’s mention of the hard-to-establish intrinsic value of cryptocurrencies. It also raised concerns about stablecoins but explicitly mentioned that these can hamper monetary policy mechanisms unless “backed by fiat currency’.
Bitcoin’s volatility restricts wider acceptance of cryptos
The world’s largest digital currency has lately been in the eye of the storm. After touching nearly US$65,000 in April, the value has dropped to below US$40,000. A tweet or two by a multi-billionaire CEO leaves a sizeable impact on the value of bitcoin and other cryptoassets.
China’s crackdown on bitcoin trading and mining also eroded the crypto market cap significantly.
Digital currencies’ lack of intrinsic value or utility continues to invite criticism from around the world, despite the wider acceptance of cryptoassets and recent positives like the newly launched S&P crypto indices and Canadian regulator’s approval for bitcoin and ether ETFs.
Enter Diem
Diem may bring the intrinsic value missing in the crypto space. It is also likely to address regulatory oversight concerns since its stablecoins will work in tandem with authorities instead of undermining their role that ranges from monetary policy to consumer protection.
The payment system around the world has enough space for improvements. Diem’s stablecoins may achieve efficiency and desired costs by utilizing the distributed database feature of blockchain that it envisages as the foundation of financial services. The original Diem whitepaper talks about the volatility and lack of scalability of cryptocurrencies. It decodes how stablecoins can serve as a valid medium of exchange with broader participation and robust compliance.
Central banks worldwide have no apprehensions about CBDCs. The Fed and the Bank of Canada have publicly revealed their intention to introduce CBDCs, but the exact time of their launch and exactly how they will serve as a digital counterpart to fiat currency is yet to be revealed.
China’s CBDC project up and running
China, meanwhile, has launched its digital yuan, albeit in a limited capacity. Shenzhen and Chengdu are the two cities where the trial phase is underway to replace currency notes with digitally held currency. Unlike cryptocurrencies like bitcoin, the digital yuan is reportedly traceable but will feature some degree of anonymity in transactions. The project is currently limited to the Chinese central bank, which will distribute digital currency to commercial banks, eventually leading to circulation among a broad group of customers. So far, the project has not used the distributed ledger technology, and the central bank will have complete control over the landscape.
G7 leaders have talked at length about the growing influence of China in wide-ranging activities. The world’s wealthiest nations cannot ignore China’s progress in the CBDC space. Although China may never warm up to stablecoins, G7 leaders can back them to some extent to accelerate the pace of CBDCs. Diem brings a payment system that promises to work with regulatory authorities without undermining their influence over market liquidity and monetary policy.
The Basel Committee’s twin approach to capital requirements for cryptoassets and separating stablecoins from cryptoassets corroborates why the two cannot be viewed with the same lens. Stablecoins are yet to establish their intrinsic value in a real-world scenario, but the fact they will be pegged to fiat currencies makes them an exciting watch.
The crypto space may head towards a major turning point, courtesy, Diem, which addresses some existing apprehensions.
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