Digital Dollar Spotlight: Tokenized Deposits vs. Stablecoins as CBDC Out
The US will be using stablecoins for retail payments within two years.
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Then, there were two: stablecoins and tokenized bank deposits are now vying for their role in the future of the US digital dollar, given a Trump executive order banning a US CBDC.
The US’s path to a digital dollar is certainly bumpy. An executive order banned the creation of a US CBDC, which is now likely to become enshrined in law as senators reintroduce a law to outlaw it.
Now, after years of hell-bent rejection of all things crypto, we’ve got an administration pushing stablecoins as the new US digital currency and talking about becoming "the undisputed Bitcoin superpower and the crypto capital of the world."
If that isn’t stunning, what is?
🔹Death of a US CBDC:
A new executive order and pending law in Congress banning a US CBDC are sad and a gross overreaction to me, a proponent of CBDCs. However, I will overcome my grief and support stablecoins and tokenized deposits with reservations.
The underlying assumption behind the ban is that CBDCs are equivalent to government surveillance and the end of American freedom, which is simply false at face value. For those even willing to entertain the possibility that this may not be true, look to analysis on CBDC privacy from Europe and the UK, which have both progressed far further in research than the US.
CBDCs became a political litmus test, and the discussion over their utility has descended into such madness that I no longer engage in it. The last time I did, I was live on a nationwide radio broadcast when asked if CBDC was “the sign of the beast.” My reply was that God favored neither Visa nor Mastercard.
In the long term, the US is making a strategic error by not having a US CBDC. Without one, the US is guaranteeing a split or fracture in the global payment transfer system. China and the BRICS, all of whom are building CBDCs, will be on one system that the US will be unable to sanction or control, while the US dollar will be on another.
The US is also surrendering its position as the dominant source of payment technology. It is, at best, a bit player in CBDC research and has no seat at the table for most of the CBDC infrastructure being built. Banning a US CBDC is akin to shooting itself in the foot.
🔹The Rise of Stablecoins:
This leads us to stablecoins and the recent Senate markups on the GENIUS (Guiding and Establishing National Innovation for US Stablecoins) Act, which looks set for passage this summer and will regulate stablecoins.
Stablecoin users dream of a world where they effortlessly carry dollar payments across the globe, traveling wherever and to whomever they wish. They have elements of that now because stablecoins fall outside of US regulations, which is why they are the leading form of crypto used in money laundering.
The GENIUS Act will align them with existing bank transfers by requiring KYC/AML equivalent to that at US banks. This took many stablecoin fans by surprise and further away from their dream world.
Stablecoin fans didn’t consider that the US could not have two forms of the dollar with different transfer rules. If stablecoins had lower AML and KYC standards than banks use, they would “short circuit” the dollar system, which is precisely what they are doing now.
But the GENIUS Act has another trick up its sleeve. It requires stablecoin reserves to be held in short-term US securities, and foreign stablecoins that do not comply cannot do business in the US, showing the long arm of US regulation.
As a result, Paolo Ardoino, whose company Tether issues the world’s largest stablecoin, posted on X that the draft legislation was an effort by its competitors to “kill Tether.” No doubt US resident stablecoins are pleased.
The greatest irony is that, in the end, stablecoin users will face the same levels of surveillance as those using CBDCs, with minimal differences in privacy protection. Keep in mind that Tether has already blocked accounts at the US government's request. The GENIUS Act will formally establish this mandatory cooperation as law.
After listening to anti-CBDC proponents proclaim that CBDCs are “the end of freedom,” one can see that there is little difference between CBDCs and stablecoins when both can be blocked and surveilled.
I like stablecoins, but my greatest reservation is that despite the name, stablecoins are anything but stable. The price of Tether for the past week varied between $0.9993 and $1.0007. That may seem small, but on a $1 million transfer, that’s an $1,400 spread between the two.
Who gets to make or lose the $1,400?
🔹Tokenized Bank Deposits:
Banks continue to pursue tokenized deposits, with JP Morgan and Citibank deposit tokens already allowing transfers for high-profile treasury accounts.
However, the project to watch is the BIS’s Project Dynamo, which focuses on the wholesale adoption and transfer of CBDCs, stablecoins, and deposit tokens. The results of this project will likely confirm deposit tokens as banks’ favorite.
While banks will issue stablecoins, as shown by the recent Bank of America announcement, they will most likely seek to digitize transfers via deposit tokens.
Banks do not love stablecoins unless they are the issuer, as they see no need to enrich a third-party company for cash transfers they should do themselves.
Another issue is that from the bank’s perspective, it is infinitely easier and cheaper to tokenize money already on their books as deposits than to set aside more cash reserves to fund a stablecoin backed by low-yield assets.
Tokenized deposits are still a new technology, and their initial development was for use in wholesale bank transactions rather than retail payments. Although they certainly could be used for retail payments and have been tested in this role, so far, the focus has been on wholesale and interbank payments.
My greatest reservation over tokenized deposits is that they maintain banks’ lock on payments. There is no “disintermediation” and it’s hard to see banks conceiving of a retail scheme that would be a good deal for consumers, given their addiction to high fees.
🔹The near future
The new stablecoin rules will make US-issued GENIUS Act-compliant stablecoins the likely champions of retail payments.
Adoption will not be without problems at the start. One merchant will likely accept stablecoins X, Y, and Z, while you may only have A, B, and C. The lack of fungibility between coins is a significant problem to overcome. This will be akin to the days when credit card terminals only took Visa or Mastercard, but not both.
Building out the necessary infrastructure to make stablecoins easy for mainstream US users will likely take 18 months to 2 years. Can you see mainstream users checking exchange prices before using a stablecoin? I can’t.
Crypto fans may protest, saying that stablecoin wallets for crypto users are everywhere. That is true, but the majority of them are not fit for purpose if stablecoins are to be scaled for use nationally.
Visa and Mastercard may also be used for stablecoin transfers, and they already have cards linked to stablecoins held in exchanges. The question remains: Why would anyone use these high-cost networks with a digital currency that promises free and fast transfers?
For the immediate future, banks will remain focused on tokenized deposits for their wholesale transactions. Their entry into markets at scale will take time and effort, as banks will have to rewire the international financial system, which will be a significant challenge. Banks may also be forced into the stablecoin markets if they become popular but have no love for them.
While tokenized deposits may find profitable internal uses, as they have at JP Morgan and Citibank, their use will remain limited for the next 2-3 years. Banks work slowly, and given the technical and legal challenges, I wouldn’t expect them to launch tokenized deposit networks at scale for at least five years.
🔹Conclusions
The US dollar is going digital, which is fundamentally good for all Americans and KYC/AML-compliant foreign users. Stablecoins will break the lock that banks and cards have on retail payments and, in doing so, provide competitive pressure to reduce payment fees.
While still in exploratory stages, tokenized deposits will likely bring a new paradigm of 24/7 non-stop transfers to wholesale markets, bringing greater efficiencies that will save banks and, hopefully, customers. Banks have no choice but to press on, lest they surrender to stablecoins.
Whether or not the US is backing the right technology for digitizing the dollar will only be revealed over time. It is estimated that the world will have 15 CBDCs by 2030, and the ecosystem that surrounds them will likely be a deciding factor in analyzing whether the US missed out on CBDCs.
Comparing the UK and EU’s planned digital euro or digital pound will also provide insights into the attainable levels of privacy and the ease of adoption. Their position as liberal democracies will make them the most comparable to the US.
Most importantly, the US made a choice. That in and of itself is a major development, given the years that the digital dollar has remained in limbo. We are embarking on a new and overdue journey into digital payments, and we should remain optimistic that the US’s skilled fintech practitioners will make payments better for everyone.
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