Fintech experts agree on two things: First, blockchain technology has the potential to upend the financial sector. Second, it will not be cryptocurrencies that will do so. Thus, over the last few years, the idea of central banks issuing digital fiat currencies, or central bank digital currencies, took center stage and increasingly came to look like an inevitability. CBDC-trackers like the one from the
This May, however, the U.S. House of Representatives took the first step in a potential
Luckily, a private sector alternative has emerged and even promises to remedy
Deposit tokens are privately issued stablecoins, i.e., blockchain-based tokens whose value is tied to the U.S. dollar. But unlike stablecoins such as Tether or USDC, deposit tokens are not simply created by any private company, yet directly tied to deposits held at licensed banks. By utilizing existing banking infrastructure, deposit tokens benefit from a unified risk management framework and can even be eligible for deposit insurance.
Deposit tokens offer several advantages over traditional commercial bank money, which accounts for over 90% of circulating money today. There are two key differentiators.
The first is instant settlement, a quantum leap compared to the days and sometimes weeks currently prevalent in international transactions. This is enabled by a simultaneous exchange of assets and money (called atomic settlement), which speeds up many transaction types such as cross-border payments and slashes the hefty costs associated with it.
The second advantage of deposit tokens is their programmability. Thanks to blockchain's smart contract capability, the tokens can be instructed to perform specific actions upon meeting certain conditions. In other words, banks can set up if-then scenarios on a tamper-proof, incorruptible ledger and thus highly automate processes.
In their promise and their centralized setup, deposit tokens are very similar to CBDCs. The major difference is the issuer. Deposit tokens are on the balance sheet of a commercial bank, CBDCs on that of a central bank. Hence, CBDCs are actually more secure for the users as the risk of default is zero. The other advantage of CBDCs is that interoperability across the economy can be mandated by law. So why bother with deposit tokens?
Traditional financial institutions have much to gain from collaboration with digital asset natives — and vice versa. It's time to realize that potential.
First, there is the pragmatic argument: Deposit tokens can be introduced and scaled much faster than CBDCs. No large Western economy will see a functioning CBDC before 2030. After the vote in the House, it is even becoming increasingly unlikely they will never see one.
Then there is the ideological argument: All innovation since the advent of blockchain has been driven by the private sector. The central bank getting into the arena would build on these private pioneers, while at the same time it would heavily impede further innovation. Private companies would compete with an actor who cannot fail commercially and who has the power to regulate them. This is anything but an efficient market.
Furthermore, there is a massive contradiction baked into the very concept of CBDCs. Should they become too popular, a liquidity shock for the banking system would be the result. In case people shift even parts of their deposits from commercial banks to the balance sheet of the Fed, commercial banks would be forced to lend less and end up more vulnerable to scenarios like bank runs.
Finally, there is the data privacy concern. Despite proposals such as anonymity vouchers, users' trust in CBDCs is devastatingly low. Privacy fares far better under a private sector solution. On the one hand, because a commercial bank's customers have other alternatives if their data is misused. And on the other, because there is an independent authority that can levy fines on private actors and even withdraw their license to operate. Not so with the central bank.
It is no wonder then that titans of traditional finance are leading the charge. As with many other blockchain applications, JPMorgan Chase
Citi
In essence, deposit tokens bridge the gap between the innovative world of digital currencies and the established trust of the traditional banking systems. With their clear regulatory framework, unified risk management and potential for deposit insurance, deposit tokens share more with CBDCs than with cryptocurrencies or even private stablecoins, yet they don't suffer from the same problems. It is thus highly welcomed that American banks are leading the way of private monetary innovation.
