By Lior Lamesh, CEO and Co-Founder of GK8
More and more countries, including the leading global economies, such as the U.S., India, and European states, are gearing up to develop their centrally-issued digital currencies. Yes, the pandemic pushed the number of greenbacks in circulation up, and yet the dollar’s future may be digital. This could result in a major challenge for America’s commercial banks—and to overcome it, they may need to expand into an area that once rallied around their undoing.
While many of the specifics of the digital dollar, including its distribution model, are shrouded in mystery, its rise could very well spell trouble for commercial banks. Should the Federal Reserve directly offer CBDC to retail clients, it will land squarely in the banks’ traditional turf, which would likely result in thousands of deposits moving from commercial banks to the Fed. Other distribution models have their own issues, like, for example, fintech companies getting even more power in the financial realm.
Of course, there are more factors in play here. Besides the distribution model, CBDC’s impact on the banking sector will also depend on the demand for the digital dollar as such, which will inevitably depend on the usability and functionality of the CBDC. Still, some of the available research indicates that global consumers would be quite open to using CBDCs. Furthermore, the shift would fall into a larger socio-economic trend for doing away with cash.
There is no telling yet whether the digital dollar will run on the blockchain or a different kind of a ledger, or whether the chain will be public or private, permissioned. Central banks seem to prefer the latter, for better or worse, as permissioned chains do not bring in the same level of decentralization that protect the integrity of an open public ledger. Either way, this is still unclear.
For commercial banks, in the meantime, both an on-chain and off-chain CBDC would likely mean a massive tectonic shift in their market. Digital technologies are very good at transforming financial intermediation, especially when there’s enough money and power behind them. And should the Fed come to banks’ domain, they'd have to move over—and seek a new role in a financial system that will never be the same again.
The new niche
CBDCs, we occasionally hear, will “kill Bitcoin,” or at least be a more efficient means of online payments than crypto. The latter, as any sane crypto user could testify, is low-hanging fruit, at least as much as it comes to giants like Bitcoin and Ether. They do, after all, infamously struggle with transaction speed and throughput. Killing Bitcoin, for its part, is never happening unless the digital dollar can somehow magically replicate the coin’s decade-long climb from $0 to around $40,000.
There is, however, a product in the crypto market that should be watching CBDCs with unease. These are stablecoins, coins with a static exchange rate against a different asset, usually USD. While offering no prospect of wild gains, as the “stable” in the name implies, such coins have their own role in the ecosystem. They grant crypto traders a way to lock in their gains on more volatile currencies or defend against a bear market.
Tether, the largest stablecoin at the time of the article’s writing, has a market cap of more than $83 billion, trailing only behind Bitcoin and Ethereum on CoinMarketCap. Other popular stablecoins throw billions more on top of that to create a lucrative industry, which happens to have a glaring reputation problem. With USD-pegged stablecoins, investors want to know the issuer has the USD or cash equivalents to back every minted coin. Not every project delivers such transparency on equal terms, which puts the haunting prospect of a bank run on the table for the industry.
If offering a digital dollar, the Fed, as the entity running the proverbial money printer, would hardly find itself cornered up in a hypothetical CBDC bank run—if that can even be a thing at all, assuming a digital dollar is equal to a physical one in all but its exact implementation. This makes for a natural edge against stablecoins, albeit with its own caveat: While stablecoins are very much part of the open blockchain ecosystem, CBDCs will most likely be secluded to their permissioned chains, if at all implemented on-chain.
Today, crypto and fiat ecosystems largely stand on their own, connected through bridges known in the industry as on- and off-ramps. In our CBDC-driven tomorrow, this principle may still hold, but these bridges may very well be different, and banks are ideally positioned to take on this function, carving out a new niche for themselves in the brave new world emerging from the blockchain.
Where the wild coins are
As experienced and trusted financial institutions, banks stand a lot to gain from working as the gateway between CBDCs, whether on-chain or not, and the decentralized crypto ecosystem. By granting users a platform to move value between the ultimate digitized fiat and the crypto space, they make an offering that suits both retail and institutional clients.
On the retail side, the demand for crypto services from traditional banks is already there. More Americans would be willing to invest in crypto through banks, a recent poll revealed, suggesting many consumers are too wary of crypto’s Wild West past and look to the trusted household names for backing when entering the space. With access to both crypto and CBDC from a single platform, they would have even more safety and versatility than they hoped for.
The institutions, on the other hand, are already dipping their toes into crypto, including banks themselves, but also investment funds, asset managers, and corporate treasurers. From the many personal conversations I have had with the decision-makers in this space, my impression was that they would prefer to work their crypto operations through traditional banks, for compliance and bookkeeping purposes.
Blockchain has more to offer to banks than a simple new role in the market. It also grants them access to new revenue streams, from fees on custodial services and crypto-CBDC swaps to yields from native staking protocols and DeFi services. Furthermore, much like the traditional deposit accounts, they would be able to offer staking and DeFi options for the stable CBDCs, adding a whole layer of utility to the central bank’s token and granting its holders lucrative yield options. All of this is sure to offset whatever losses they may or may not incur from a CBDC rollout.
In the world of finance, just as in any other field, things never stay the same for too long. As nations move toward CBDCs and the crypto space continues to grow and develop, banks may find that the very nature of financial intermediation is shifting. By working as a bridge between the two kinds of new money, they can continue to thrive and grow their bottom while keeping up the pace with the world.
About the Author
Lior Lamesh is the Co-founder and CEO of GK8, a cybersecurity company that offers a self-managed end-to-end custodial platform with true cold vault and hot MPC capabilities for banks and financial institutions. Having honed his cyber skills in Israel’s elite cyber team reporting directly to the Prime Minister's Office, Lior oversees the development of GK8’s on-premises hardware and software. Over the past four years, he led the company from its inception to a successful acquisition for $115M in November 2021. In 2022, Forbes selected Lior and company Co-Founder Shahar Shamai for its 30 Under 30 list.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.