What are the differences between cryptocurrencies, stablecoins, and CBDCs?

The use of cryptocurrencies is skyrocketing. By the end of 2021, there were 1.5 million daily crypto transactions, and this number is expected to increase, with 75% of users saying they would like to use crypto as a method of payment for goods and services. Some big brands are already letting consumers pay with cryptocurrencies to meet this demand, but banks and other financial institutions remain somewhat wary of offering crypto as a payment option for their underlying clients.

Regulated financial institutions have so far been slow to embrace this new way of transacting, seeing cryptocurrencies as being far riskier than fiat currencies. Meanwhile, specialist acquirers, PSPs, and even card schemes, including Mastercard and Visa have begun handling crypto.

What are cryptocurrencies?

Cryptocurrencies are defined as being a form of digital tokens that exist on the blockchain – a distributed and decentralised ledger. As of May 2022, there are more than 19,000 different cryptocurrencies in existence.

Along with Bitcoin, which is probably the best-known cryptocurrency, there are thousands of altcoins. With celebrities and influencers such as Elon Musk and Bill Gates stating that they are investing in crypto, numerous altcoins are entering the mainstream and becoming more accessible, including Ethereum, Terra, Litecoin, and Dogecoin.

Many cryptocurrencies are incredibly volatile, which has resulted in the rise of stablecoins.

What are stablecoins?

Stablecoins are different from Bitcoin and many other altcoins as they tie their value to an asset – this may mean being pegged to a fiat currency (such as USD), another more established cryptocurrency, or a commodity like gold as a means to stabilise its price.

However, there are also algorithmic stablecoins, which are not pegged in this way, and are instead backed by an on-chain algorithm that facilitates a change in supply and demand between the stablecoin and another cryptocurrency that bolsters it.

Financial institutions are recognising the benefit that comes with this reduced volatility in attracting wider adoption by consumers and merchants. Popular stablecoins such as USD Coin (USDC) and Tether (USDT) are linked to the value of the US dollar and backed by reserves, and are used by well-known crypto exchanges such as Binance, Kraken and Coinbase. Stablecoins offer the possibility of very rapid settlement, rich transaction data and lower volatility than other cryptocurrencies.

Although there is still some risk of volatility with stablecoins, those pegged to a fiat currency are arguably far more financially stable than those that are not.

What are Central Bank Digital Currencies (CBDCs)?

Many Central Banks have begun experimenting with Central Bank Digital Currencies (CBDCs). CBDCs are a type of fiat currency issued by central banks where the managed digital ledger may or may not run on blockchain.

CBDCs promise many of the advantages of crypto, such as faster digital transactions with richer data, but also offer much lower volatility since they are digital versions of national currencies backed by government commitment. Additionally, CBDCs have been touted as a solution that increases financial inclusion, and provides the means for safer, faster and cheaper payments.

How can Banks and Payment service providers prepare for stablecoins and CBDCs?

Both stablecoins and CBDCs have the potential to reduce processing fees and the time taken to execute cross-border payments by bypassing correspondent banking networks.

Banking Circle has recently released a white paper that explores the challenges and opportunities for financial institutions that want to offer crypto payments.

To find out more, download your copy here.

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