Exploring new forms of digital money

The evolving landscape for new forms of digital money is marked by a growing diversity of digital financial instruments. This innovation is transforming how money is created, managed and used. In this blog, we explain the different forms of both publicly and privately-issued digital money in more depth.

The growth of new forms of digital money accelerated in 2019 when Facebook (now Meta) announced the launch of its Libra project. Later rebranded as Diem, Libra aimed to create a global digital currency that would provide financial services to billions of unbanked people globally.

The project faced ongoing regulatory challenges and was dissolved in 2022, but Libra/Diem nevertheless played a significant role in raising awareness about digital currencies amongst regulators. Concerns about a multinational company with Meta’s global reach launching its own currency – and potentially challenging the monetary power of nation states – spurred multiple ongoing experiments with, and later real-world implementation of, Central Bank Digital Currency as well as speeding up developments in the stablecoin sector. Below we explain these different types of digital money, as well as others that have since emerged.

Central Bank Digital Currency (CBDC)

A digital form of a country’s national currency issued and regulated by the central bank. Unlike cryptocurrencies, which are decentralised and operate on blockchain technology without any central controlling entity, CBDCs are centralised and represent a digital version of fiat money such as the Dollar, Euro or pound Sterling.

Stablecoins

A type of digital money designed to maintain a stable value relative to a specific asset or a basket of assets. Unlike cryptocurrencies which can be highly volatile, stablecoins are designed to be more predictable in value. This makes them more suitable for everyday transactions or savings, or to use like cash as a medium of exchange.

Different types of stablecoins exist with different benefits and risk profiles:

• Fiat-Collateralised stablecoins: Backed by reserves of fiat currencies. For every stablecoin issued, an equivalent amount of fiat currency is held in reserve.
• Commodity-Collateralised stablecoins: Backed by reserves of commodities like gold or real estate.
• Crypto-Collateralised stablecoins: Backed by other cryptocurrencies. To account for the volatility of the collateral, these stablecoins are often over-collateralised.
• Algorithmic stablecoins: Rely on algorithms and smart contracts to control the supply of the stablecoin, maintaining its peg by adjusting the supply based on demand.

Stablecoins are a significant innovation offering a bridge between the volatility of traditional cryptocurrencies and the stability of fiat currencies.

Tokenised deposits and tokenised e-money

Both are digital representations of traditional financial assets on a blockchain, but they differ in their structure, regulatory framework, and use cases.

Tokenised deposits represent traditional bank deposits that have been converted into digital tokens on a blockchain. They are issued by banks and represent a claim on the bank’s reserves.

Tokenised e-money represents electronic money issued by regulated entities, such as e-money institutions, backed by traditional fiat currency held in reserve. They are used primarily for digital payments.

Tokenised deposits offer the stability and trust associated with traditional banking, while tokenised e-money provides greater flexibility and innovation in digital payment services. The choice between the two depends on the specific needs and regulatory environment of the user.

Bridging traditional and digital finance

The growth of new forms of digital money is an important factor in facilitating the growth of tokenisation because, when trading tokenised assets, a cash leg is necessary to complete the transaction. Using a CBDC or stablecoin to settle the cash leg of the transaction helps to integrate tokenised asset trading with the traditional financial system and allows investors and institutions accustomed to conventional financial practices to participate in the tokenised asset market more easily.

Non-interest-bearing stablecoins and CBDCs nevertheless have their limitations, and alternatives which can generate yield – such as tokenised money market funds – are likely to have a bigger role to play in the future.

The future for digital money

As the tokenisation of real-world assets gathers pace, the use of new forms of digital money is only likely to increase. According to the Atlantic Council’s CBDC Tracker, at the date of writing, 134 jurisdictions representing 98% of global GDP are now exploring a CBDC, and the stablecoin market also continues to grow and find new use cases including micro payments, remittances and cross-border payments.

Whichever form it takes, digital money will form an integral part of the financial markets in the years to come.