The rising currency for the future -CBDC

Tokenisation and our future

Tokenisation is defined as the process of turning real-world assets or ownership rights into digital code on a blockchain or secure ledger. This is the key component in modern and future of decentralised finance. Benefits of tokenisation can be found from the improved efficiency of trade to the higher access to different property markets for buyers and sellers. With the “DeFi” sector still growing and the trajectory of 16% of assets being tokenised by 2035¹, it is essential for all stakeholders to structure a system that could benefit the society and limit the risk for financial disaster in its sector.

Digital currencies and their importance

However, any trade requires a medium of exchange. Before 1973 within the Bretton Woods system, the medium of exchange, the USD, was tied with the value of gold, after 1971 most currencies had no collateral and most of their value was based off the trust in the central bank and the country’s economy. Now for “DeFi”, the trading currency varies, the most common type currently is cryptocurrencies with Bitcoin being dominant. Yet due to the lack of collateral, its value has a much higher volatility; easily being influenced by news and rumours.

If the problem is solely the lack of collateral, then the solution could be stable-coins, with a currency that is issued by any company and has a strict collateral ratio (An example is Tether with 1USDT being bound to 1 USD), trust is built and the problem is solved, isn’t it？

It isn’t. Although stable-coins seem to be an ideal solution, the risk of Peg-breaking and closure of the issuing company do exist. Furthermore, in the example of USA T-bills, an optimistic prediction of 1 trillion USD of T-bills will be bought using stable-coins in 2035², this brings concern about the potential financial disaster of government bonds experiencing a liquidity and a facing of a run on collateral for CBDC issuers, as one of the biggest buyer of short term government bonds is using these bonds as collateral.

Central Bank ideal solutions and the introduction of CBDC

Despite stable-coins not being the perfect ideal solution, and the lack of control over decentralised finance is also another reason why there is an increased interest to intervene and introduce its own currency for many central banks across the world. The aim of a central bank is to provide stable pricing and economic growth to its country through monetary policy. One of the main tools in monetary policy is the use of Central Bank Policy Rate or issuing new currency. Yet in decentralised finances as the interest rate is primarily based on demand and supply, there will be impaired monetary policy transmission. This means that if there is any chaos, over-optimism, or pessimistic in these markets, the Central Bank has little to no ability to intervene but to suffer the effects that it brings to real finance.

That is why most developed countries are interested or currently developing Central Bank Digital Currency-CBDC. As a version of digital currency that is issued and backed by the central bank, CBDC is born with the legal authority and market trust that a normal currency has, and additionally builds on the trust that the market has and the nature of “DeFi”, CBDC are also considered as one of the most efficient currency for trading. Furthermore, the Central Bank is now not only able to control the amount of CBDC in the market, but also allow more fin-tech to be incorporated into CBDC. For example with the help of Distributed Ledger Technology-DLT, the government would be able to trace transactions more easily, making cybercrime more difficult.

Benefits in market and trade

The introduction of CBDC is more than just an introduction of influence for central banks, CBDC also symbolises the introduction of “atomic settlement” (DvP) for cross-market trade. As CBDCs are currencies that represent a country rather than a market or company, a group of countries can further utilise a m-bridge project where mCBDC can be used to facilitate real-time, point to point, cross-border payments/transactions.Compared to the traditional T+1 or T+2 settlement period, CBDC can fully eliminate the risk of counterparty fault and timing mismatch.

CBDC’s ability to facilitate cross-border transections can be exemplified by Project Ensemble Sandbox in Hong Kong that started in August 2024, which not only proves all the benefits and technology for CBDC are highly achievable in real life. It further demonstrates the possibility of a seamless integration of “DeFi” with “TradFi”. As in Project Ensemble the Hong Kong Monetary Authority is able to tokenise real commercial bank savings and achieve atomic settlement to MMF and green bond, the core capital in “TradFi” could be starting to move to “DeFi” and DLT³

Beyond the international trade efficiency, what is the point of CBDC if it’s just a digital version of traditional currency? What benefit does it offer to normal citizens compared to a traditional dollar, if it’s almost the same? The answer for this could be that CBDCs also offer revolutionary tools for domestic economic management with the future of “nowcasting” and the introduction of non-bias macro-economic policy making.

Traditional currencies hide their flaws for monetary policy making. As there is no way of tracing the usage of money, there is also no way for policy makers to access a full detail report of current market but an inaccurate report of a market 3 months ago. Furthermore, by letting one of the most important factors of trade be heavily influenced by political and personal bias of a country, which over time will damage investor and business confidence. However, with CBDC traceability and other real time data (like satellite light image of harbour and city or credit card spending) governments could be able to produce real-time indices . Whilst a high-frequency real time index like the WEI exist already, with the increasing importance of decentralised finance in the future, the importance of having data on the active “DeFi” trade are significant.⁴Therefore, that is another example of why central banks are trying to have fintech like DLT in place for the potential issuing of CBDC.

With the ability of “nowcasting” and potential algorithmic fine-tuning of interest rates, this will benefit normal consumers and an economy’s growth. As market and normal consumer can enjoy monetary policy that is relatively not influenced by politics or bias compared to the monetary policy making institution like the Fed that we have now, industry can receive more targeted subsidies in real time and higher control of economic cycle can be achieved.

Question: The Paradox of a centralised “DeFi”

Higher efficiency, stable currency and platform for trade, better policy making are all considered as the potential benefit of CBDC. Yet at what cost? Whilst there isn’t a straight answer to it, there is definitely concern about the autonomy of “DeFi”. Decentralised Finance is defined as a financial system that has no central point or a centre of power. If the currency that “DeFi” is trading in gives authority and power for an institution to control, doesn’t it go against the aim of “DeFi”? A core benefit of “DeFi” is making the market more solely dependent on demand and supply with little to no influence of government yet with CBDC it could be argued that it brings all of us back to centralised finance. If the CBDC become a reality, there is an indication that authority can even control what an individual is purchasing and even perhaps an introduction to a programmable money/spending constraints

Ultimately, the future is unpredictable. There exists an enormous potential and benefit for using CBDC to allow a sustained growth in the decentralised finance but at what cost? The future of whether we should have a centralised “DeFi” system is up to the market and government to decide. Yet one point is clear, the benefits of CBDCs have to build up on careful political and economic consideration from government and a stable system of politic and trade. 16% of our market will be tokenised and trade in “DeFi” in 2035 and more will come, it will be a future that hides enormous potential and moral questions at the same time.