Web3 Impact on Financial Services: New Digital Forms of Money

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Now let’s dive into the latest instalment of our “Web3 Impact on Financial Services” series. If you have just joined us, be sure to have a look at the previous articles.

In summary, two weeks back we started this series by discussing how Web3 is fundamentally transforming financial services by replacing the existing financial rails, enabling new forms of money and representations of real-world assets. (see article here).

Last week, we covered the new financial rails - the blockchain ecosystem (article available here). So, today, we will cover the new forms of money.

What is money?

Money permeates every aspect of our lives, yet the way we think about money varies. Some think of it as a digital card on their phone, a physical card in their wallet, or even cash.

The reality is that until now, money was a combination of public and private forms (notes issued by central banks and deposits by commercial banks). Both these forms were provided by centralised financial entities (central banks and banks).

However, the launch of Bitcoin has pushed the notion of money in a new direction.

New Digital Forms of Money

The Genesis: Bitcoin (cryptocurrency)

Bitcoin, the pioneering cryptocurrency, emerged with the vision of enabling peer-to-peer payments. In 2010, the first exchange of Bitcoin for goods took place – the purchase of a pizza!

Since then, other brands and stores have started to accept Bitcoin. In 2021, El Salvador went one step further and made Bitcoin a legal tender, requiring all businesses to accept it.

However, the high volatility and uncertainty of Bitcoin price have restricted its mainstream adoption for daily transactions.  

Imagine if you go buy milk and the price of bitcoin as decreased significantly that it no longer covers your purchase, or similarly the seller may be be hesitant to accept bitcoins if they expect that the value could go down.

Hence, many see Bitcoin not as a means of payment but as an investment asset.

The stable currency: Stablecoin

In 2014, Stablecoins emerged as a solution for users and businesses seeking price stability. Stablecoins maintain a stable value by being pegged to a physical commodity, fiat currency or algorithm.

Since its origin, stablecoins have become extremely popular and are used in several cases. For simplicity, we will divide stablecoins into three areas: traditional finance, defi, and store of value.

• Traditional Finance: Stablecoins are used both by businesses and customers for retail and services, cross-border payments and remittances.
• DeFi: Stablecoins are used across the DeFi ecosystem for settlement, farming, and other activities.
• Store of value: In countries with high inflation, stablecoins are used as a safe way to store value.

While the initial stablecoins were provided by technology and DeFi startups, banks have now also joined the race and issued fiat-backed stablecoins, namely Paypal and Societe Generale.

The government’s response: CBDCs

A number of countries have been exploring the opportunities of CBDCs for a number of years. However, the true inflection point seemed to have occurred when Facebook announced the Libra project. Libra was pitched as a mainstream cryptocurrency that could be spent online or offline, much like the dollar.

Why was Libra’s project so significant?

While there was a lot of development in the crypto industry, it was still seen as outside the mainstream economy. However, Facebook’s scale and access to Web2 users could become a true challenger to the traditional government-run financial system. The project was eventually closed down due to a number of setbacks and regulatory pressure.

Ok, but what are CBDCS?

CBDCs are, in simple terms, a digital version of fiat currency backed by a government. There are two types of CBDCs being explored: retail and wholesale.

• Retail CBDCs are provided to the general public, for all payments of goods and services, similar to cash but in digital form.
• Wholesale CBDC is issued only to financial institutions for transactions and settlements. A key use case is cross-border payments.

According to the Atlantic Council Geoeconomics Center’s CBDC tracker, 134 are currently exploring central bank digital, an increase from only 25 countries in 2020.

Both UK and Europe, for example, are currently exploring the issuance of a retail CBDC (the decision will not take place for a couple of years). One of the key issues is privacy. Many believe that central banks could use CBDCs as a form of surveillance. And so, the use of the latest privacy technologies is being considered by central banks.

The Banks’ response: tokenised deposits

Tokenised deposits are often referred as the response from banks. They are in simple terms, a digital representation of deposits held in a bank. Their main use case would for banks to move money internally between different clients.

Final Thoughts

The emergence of Bitcoin, stablecoins, CBDCs, and tokenised deposits represents a paradigm shift in the concept of money. While initially this ecosystem was only adopted and issued by FinTechs and other startups, we have since seen a shift with more traditional players exploring or even issuing new forms of money. For example, JP Morgan issued Tokenised Deposits and Societe Generale issued their own stablecoin.

While it still unclear what the future holds and which of these forms will prevail, the fact that traditional players and central banks are now exploring these new forms, highlights the potential they bring.

Until next time!

If you are enjoying this newsletter, you may want to grab your copy of my new Book “Web3 in Financial Services”, where we demystify the complexities of Web3 and explore its profound impact on the financial services industry. While the book only comes out in June, you can pre-order now via Kogan Page or Amazon (available worldwide).

This is a new and exciting space, so ideas and perspectives may change as we learn more and technology improves. 

Any views or opinions represented are personal and belong solely to the author and do not represent those of people, institutions or organisations with which the author may or may not be associated in a professional or personal capacity unless explicitly stated.