Decentralized Finance (DeFi) is an alternative financial system which utilizes blockchain networks, such as Ethereum, to deliver cheaper and faster financial services to consumers and businesses through crypto currencies. As the name suggests, DeFi is not centralized or tied to a specific financial institution. Consequently, these services are globally available 24/7/365, don’t take holidays, weekends, or evenings off, which enables near instant if not same day settlement (vs. two to five business days for many traditional cross-border transactions at higher transaction fees). We have previously opined on the exploding use of US Dollar backed stable coins overseas, like Circle’s USDC and Tether’s USDT.
There is also a conceptual tug of war brewing in the land of web3.0 regarding Centralized Bank Digital Currencies or CBDCs. The US Dollar (USD) is an important reserve currency for world trade as it is utilized for almost half of all international transactions. But the process can be cumbersome with extended settlement times and fees. What if those same transactions could be immediately and fully funded by an electronic token, backed by the US government just like cash, and the institutions in question could join a network where all participants benefit from the same efficiencies? Large and small businesses would receive transparent and more equal treatment in transactions of all sizes. Correspondent banks and costly middlemen would be replaced by direct connections to each other. The US is behind the rest of the world in terms of digital currency use, and readers may recall overseas $22 trillion in transactions were enabled last year.
In addition to Circle and Tether, utility token pioneers Ripple and R3 are moving ahead with their own blockchain based solutions. So, does the US need or want CBDC? Some have suggested the US produce a special CBDC for financial institutions only, and allow consumers to choose their own service provider for P2P and C2B transactions (just like choosing between different types of payment formats like credit, debit gift card etc.). This has raised the hackles of consumer advocate groups who have warned against government spying on purchasing patterns and the ability to turn off access to certain goods and services. Since no other country carries the same currency weight as the US there may well be benefit to others, like China, to actively standardize their trading partners on a Yaun (CNY) CBDC. If successful, this would potentially dislodge the US Dollar from those transactions and raise the standing of the Yuan internationally, while potentially improving the speed and lowering the administrative cost of those purchases for all concerned.
We are mindful of the BRICS organization, also previously written about, which may act as a captive audience to expand China’s CBDC. We are watchful of these developments, and take them seriously. But, before anyone panics, neither the Yuan nor China is trusted – first because the government rules by fiat (a reason why many wealthy Chinese park their money in US hard assets), and secondly, because China doesn’t freely float its currency (i.e. artificially low or cheap). This is a critical part of China’s export economy ensuring that the exchange rate always favors the purchase of Chinese goods over other countries with stronger currencies. It is also noteworthy that the pegged Yuan (to USD) feeds a Chinese economy that requires perpetually cheap labor and government subsidies (selected industries receive subsidies which lowers their cost of capital).
We believe there may be a place for CBDC in the US under certain circumstances, but think the free market, as usual, is ahead of the US government.
