Charting the Co-existence of Stablecoins and Central Bank Digital Currencies  

Money, although conceptually elusive, serves a distinct purpose in the modern economy. Our current financial framework intertwines private and public sectors, with the former generating most of the currency. Governmental bodies, including central banks, play a supportive role by issuing legal tender, overseeing regulations, maintaining payment systems, and offering financial safeguards. Banks and other regulated financial entities within this structure produce private money, operating under strict guidelines that grant them access to government backing.  

Our forthcoming article emphasises the importance of balancing private and public monetary systems as we enter an era of financial innovations like stablecoins and central bank digital currencies (CBDCs). We argue that true innovation typically emerges from private sector entrepreneurs, as both traditional banks (the primary creators of private money) and central banks (the sole issuers of public money) lack the necessary motivation and capabilities to drive significant changes. We stress the need for effective safeguards to mitigate risks and address potential negative externalities arising from the evolving dynamics between private and public financial systems. 

Historically, the United States stands out for its unique approach to maintaining public monetary sovereignty while encouraging the creation and innovation of private money and financial institutions. In this system, the Federal Reserve (Fed) plays a pivotal role in determining which financial entities produce the most reliable forms of currency. The Fed’s responsibilities encompass, among others, managing monetary policy, conducting open market operations, setting bank reserve requirements, and overseeing lending practices. Under this framework, US banks integrate lending, payments, and deposit-taking into their business models. They adhere to stringent regulations in exchange for significant benefits, including access to the Fed’s master accounts, clearing and settlement systems, and financial safety nets such as deposit insurance. Additionally, they benefit from a specialised resolution process for troubled institutions. Entities operating outside this privileged circle lack these advantages and must typically rely on banks to access clearing and settlement systems. 

Despite the long-lasting public-private partnership, the current system leaves much to be desired. Banks have operational constraints, leaving millions of financially excluded individuals in the US without proper access to the financial system. This lack of access raises significant concerns regarding social justice, equity, and the potential for economic growth and productivity among the most vulnerable segments of the population.  Moreover, the current payment systems have significant inefficiencies. The US payment, clearing, and settlement infrastructure does not fully support real-time transactions, creating barriers to economic activity. These issues highlight the need for reform.  

Our article addresses the inefficiencies of the current financial framework and discusses how private and public initiatives can support each other without impeding progress. We assess two initiatives: CBDC and stablecoins. For the purpose of definition, CBDC is a publicly issued digital fiat money with the potential to be universally accessible and to have legal tender status. Stablecoin is a privately issued crypto-asset that maintains a stable value by being pegged to a relatively stable asset or a pool of assets, such as fiat currencies or commodities. We ask how CBDC and stablecoins can coexist.  

The concurrent existence of CBDCs and stablecoins has far-reaching consequences. Stablecoins are lauded for enhancing speed and enabling atomic settlement in payment and remittance services while offering accessibility and cost-efficiency. Yet, they face regulatory hurdles, with authorities expressing concerns about their potential impact on financial stability, consumer protection, and existing monetary frameworks. 

Conversely, CBDC initiatives are frequently viewed as the public sector’s answer to stablecoins. Numerous nations contend that CBDCs represent a critical public innovation, arguing that stablecoins threaten central banks’ monetary policy control and sovereignty. The question arises: could governments render stablecoins obsolete by introducing CBDCs? While possible, this strategy may prove ineffective, particularly if the goal is to modernise payment and settlement systems and enhance financial inclusion. 

Our reservation finds its roots in Schumpeterian thoughts, which posit that technological progress is an inherent feature of capitalism that leads to improved resource allocation. With their limited resources, governments cannot afford the trial-and-error process or iterative product launches that characterise innovative development. Hence, conventionally, governments have rarely been the primary drivers of innovation, which typically emerges from entrepreneurial endeavours. Central bankers may lack the necessary expertise for such innovations.  

We also consider the case of legacy banks and their ambition to innovate. We argue that banks, as established and conservative firms, are usually slower to abandon old approaches and products compared with disruptive fintech firms. They also face regulatory pressure to innovate in a direction chosen by central planners—regulators. As a result, some banks may engage in technological innovation to improve their services, while others may not.   

The push for enhanced innovation underscores the necessity for effective regulation. A well-crafted regulatory framework for stablecoins should acknowledge the diversity of their business models and implement a risk-based approach. Considering the risks associated with different stablecoins, this nuanced strategy may prove more effective than a uniform regulatory approach. The aim is to balance fostering innovation and managing risks, enabling stablecoins and CBDCs to coexist and potentially creating a more robust and competitive global payment ecosystem. 

It is crucial to develop mechanisms that identify the most effective technologies and practices, improve public-private sector coordination, and manage the evolving technological landscape. This regulatory approach should protect state interests while addressing inefficiencies in payment systems, potentially offering a new paradigm for the coexistence of public and private forms of money. We carefully consider the risks of stablecoins, including user risks, systemic risk concerns, monetary policy and sovereignty problems, conventional financial risks, asset risk, and many others. We also weigh these risks against the benefits of innovation, CBDC projects and relevant impediments, and the status quo, i.e., the current money structure and innovation within the existing financial system.

Depending on the design of stablecoins and related arrangements, they might be closer to money market mutual funds (MMFs), bank deposits, or payment systems. This plurality of business models suggests that a diverse reform could be more effective than a prescriptive one-size-fits-all approach. A plurality of stablecoin designs also calls for smarter regulatory approaches, CBDCs do not necessarily need to compete with well-regulated stablecoins, which could be given access to the federal government’s safety net.

Provided better interoperability between new forms of digital money is achieved (through, eg, APIs, smart contracts, and standardized protocols), users could be able to convert seamlessly from stablecoins to CBDCs and vice versa. In an ideal scenario, a sovereign-backed CBDC should ensure stability and confidence in a high convenience yield of money, whereas private stablecoins could provide user-friendly interfaces and reasonable safety achieved through better regulation and their (possible) access to the federal payment rails.

This coexistence of public and private digital money may offer individuals and businesses options for conducting transactions and managing financial affairs. Private money could cater to specific market niches that public money might not adequately address. An obvious example is providing private services to individuals who are underserved by traditional financial institutions, which would lead to greater financial inclusion, especially in regions with limited access to traditional banks.

The coexistence of the public and the private could accommodate different economic actors and adapt to the changing technological landscape, something innovative private firms do well. Private parties could continue experimentation and technological development that central banks can neither afford to engage in safely nor have the right incentives and expertise for. Put another way, while public money can offer stability and trust, private money can ensure more innovation and diversity of solutions, and the relationship between the two will continue to evolve as we grapple with new technologies.

Our key conclusion is that public money, including CBDCs, and private money, such as stablecoins, should continue to coexist. Regulators need to adapt to this evolving coexistence and plurality of monetary instruments and create reliable regulatory safeguards for this public-private economic partnership. Better, smarter guardrails for the evolving coexistence of private and public money must simultaneously capitalize on the benefits of private innovation, control its negative externalities, safeguard financial stability, and protect consumers. This way, we will have a chance to use the synergetic coexistence of public and private money to solve the longstanding problems of payment inefficiencies and financial inclusion. By contrast, entrenching the status quo and preserving the current regulatory and payment models could be a missed opportunity to address the inefficiencies of the existing system.

The authors’ complete article can be accessed here.

Yuliya Guseva is a Professor of Law at Rutgers Law School and the Director of the Fintech and Blockchain Program.

Sangita Gazi is a doctoral candidate at the University of Hong Kong.

Douglas Eakeley is the Alan V. Lowenstein Professor of Corporate and Business Law and Distinguished Professor of Professional Practice at Rutgers Law School and the Founder/Co-Director of the Rutgers Center for Corporate and Business Law.