The world of digital cash is divided into two camps. The traditionalists want a public authority to remain in charge of providing a safe medium of exchange for people to settle claims against one another. Or else, they say, private money could become as unreliable as in the pre-US-Civil-War era of wildcat banking, when notes issued by a lender in Tennessee would be discounted by 20% in Philadelphia.
On the other hand, the experimentalists believe that excitement around central bank digital currencies, or CBDCs, is a fad — a bit like the 1980s “parachute pants.” As long as a nation has established a unit of account, it’s fine to step aside and allow the nonstate sector to come in with its own stablecoins, electronic representations of value pegged to the dollar, euro, yen, or the pound. Who needs the Federal Reserve to issue a digital dollar to compete with China’s e-CNY when there’s already Tether?
While there’s no resolution in sight to this public-private debate, there’s now a third element — deposit tokens. The germ of this idea got validated recently as part of Project Guardian, a collaboration between Singapore’s central bank and the financial industry to explore the economic potential of asset tokenization. JPMorgan Chase & Co. turned a Singapore dollar deposit into a digital asset, programmed it to trade only against some known wallet addresses and demonstrated that institutional-grade security is possible on a public blockchain.
Since nine-tenths of all money in circulation is bank deposits, the very possibility that all of them could potentially get behind “smart contracts” — self-executing software code that triggers exchange of monetary value when certain conditions are met — is a big deal.
Consider a real-estate transaction. Use of escrow accounts in conveyancing — when property changes hands — is fairly routine. Less prevalent, but not entirely unknown, is the problem of the lawyer operating the escrow running away with the funds. Now suppose that the purchase consideration is taken out of your deposit account and put in a digital piggy bank. The seller has a cryptographic key, which can only be used when the apartment is sold. That’s the smart contract. If the deal falls through, you can break open the money box.
Let CBDCs and stablecoins, both of which are retail products, compete for the headlines. The behind-the-scenes disruptor may well turn out to be the humdrum deposit. There’s much for it to do. The risk that one party in a trade may fail to deliver what it owes to the other is a $2.2 trillion-a-day nightmare for cross-border payments. Blockchains offer atomicity: The two legs of a trade either succeed together, or fail in unison. Digitized deposits could make settlement risks go away. Consumers will pocket the efficiency gains as reduced costs, according to a joint report by consulting firm Oliver Wyman and JPMorgan’s Onyx digital platform:
“In 2020, it cost $120 billion and on average took 2-3 days in settlement to move $23.5 trillion across borders. And while we estimate that a multi-currency CBDC could cut costs by 80%, down to approximately $20 billion, deposit tokens could unlock similar benefits by reducing fees, settlement times, and counterparty risks, and by enabling more direct funds transfers.”
Most stablecoins hold their fixed value by virtue of their 1:1 backing. Every $1 token minted by Tether or Circle Internet Financial Ltd.’s USD Coin can — at least in theory — be redeemed by its issuer by liquidating US Treasury securities or similar high-quality, liquid assets. But not everyone thinks they’re the future of money. “Most stablecoins trade close to par when all is well,” says Agustín Carstens, the general manager of the Bank for International Settlements. “But things are not always well.”
A CBDC, by contrast, carries the solemn promise of payment at par by a country’s ultimate money-printing authority.
A tokenized deposit sits somewhere in the middle. It’s a claim on the issuing bank, so not really a sovereign liability. And yet, most people will treat it as such. That’s because the elaborate protections of deposit insurance and banking supervision that give customers of financial institutions the confidence to park money with them will continue to be available. Unlike stablecoins, tokenized deposits won’t need 1:1 backing. And that may be a good thing. It’s economically more efficient to leave the world’s limited supply of safe assets free for more productive uses than to trap them into greasing the wheels of blockchain transactions.
In the ideal world of the traditionalists, tokenized deposits, together with CBDCs, may render stablecoins superfluous. According to Carstens, it’s possible to imagine a future where commercial bank deposits and central bank money are “in the same programmable form on an integrated platform — a unified ledger.”
For now, though, the experimentalists are winning, The shutting down of Silvergate Exchange Network, or SEN, by Silvergate Capital Corp., the failed crypto-exposed bank, has removed one important rail for institutional investors to exchange dollars for digital tokens. “With the death of SEN, stablecoins will likely become even more ubiquitous among traders,” according to Kaiko, a blockchain analytics firm. “Rather than deposit your dollars with an exchange, you deposit them with a stablecoin issuer, receive stablecoins, and then transfer those to an exchange.”
The traditionalist camp is watching these developments with a sense of alarm. CBDCs, where they’ve been approved, are mostly undergoing trials; the unified-ledger vision is still a utopia; and despite all the turmoil in the crypto universe over the past year, private stablecoins are becoming more crucial to investors, not less. All the more reason to bring deposit tokens out of the lab and into the real world.