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Economic Brief
July 2022, No. 22-26

Central Bank Digital Currencies and Regulatory
Alternatives: the Case for Stablecoins
By Bruno Sultanum

Central bank digital currencies (CBDCs) have been in the spotlight as the Federal
Reserve and other central banks explore introducing them. At the same time,
stablecoins are also growing in popularity, and many people including politicians
and regulators have started discussing how to properly regulate their issuance
and use. In this article, I discuss the question of whether a regulatory framework
for stablecoins — where regulated banks can issue stablecoins backed 100
percent by deposits at the central bank — could serve as an alternative to issuing
Stablecoins are privately issued digital currencies generally backed by safe and liquid
assets, with their value typically pegged to the U.S. dollar. While introducing CBDCs has
received more attention than regulating stablecoins, I argue in this article that privately
issued stablecoins could be equivalent to CBDCs — particularly in the U.S. — under some
conditions. That is, in the presence of a good regulatory framework for stablecoins, CBDCs
could be considered "inessential" in the terminology of monetary theory discussed in the
1973 book chapter "On the Foundations of Monetary Theory" and later developed in the
2010 book chapter "The Mechanism-Design Approach to Monetary Theory."
I divide the article into three parts. In the first section, I discuss the potential regulatory
framework for stablecoins. In the second section, I describe how CBDCs could become
inessential in the presence of such a regulatory framework. In the third section, I provide
some final thoughts and conclude.

Regulatory Framework for Stablecoins
In November, the President's Working Group on Financial Markets (PWG), the Federal
Deposit Insurance Corp. (FDIC) and the Office of the Comptroller of the Currency (OCC)
released a joint report on stablecoins, which highlights that stablecoins could improve the

U.S. payment system but also create financial risks if unregulated. In general, realizing any
benefits from stablecoins will likely require regulation. Unregulated stablecoins would not
be easily trusted, hence limiting their use as means of payment.
The report's main recommendation is for Congress to enact new legislation to allow for
regulators to oversee stablecoins. The report says such regulation should:
Require stablecoin issuers to be insured depository institutions
Give flexibility for regulators to impose restrictions on wallet providers (a form of
custodian for digital assets)
Promote interoperability among stablecoins and other measures to prevent market
concentration and potentially restrict data collection
The last point likely implies that stablecoins pegged to the U.S. dollar would have to be
redeemable in U.S. dollars, either directly or through deposits in the bank issuing the
stablecoin. Two items might be worth adding to the above list relating to implementing
such regulation: a two-tiered system and appropriately tailored regulations.
Two-Tiered System of Stablecoins

Consider first a two-tier system for stablecoins:
One tier backed 100 percent by deposits (or reserves) at the Fed. (This could also be
described as synthetic CBDC.)
One tier backed by a mix of liquid and safe assets.
I refer to stablecoins backed by reserves as synthetic CBDC because the term synthetic (in
finance) refers to a combination of assets that pays the exact return of another asset. For
example, a synthetic bond XYZ can be created by buying a risk-free bond and selling a credit
swap on bond XYZ. Thus, the stablecoin is a synthetic CBDC because it is fully backed by
reserves and can be redeemed as such.
One counterargument to creating a two-tier system might be that if the Fed were to
regulate stablecoins as proposed by the aforementioned report, a depository institution
could make them fully backed by reserves unless regulated otherwise, making a second tier
That said, a two-tiered system directly acknowledges that regulation would create a
framework for synthetic CBDCs and allows for further simplification of regulatory
requirements for institutions issuing only stablecoins backed 100 percent by reserves. It
would also preserve the ability of issuers to create stablecoins not fully backed by reserves.
That would naturally be the case, for example, for stablecoins not pegged to the U.S. dollar.
Appropriate Levels of Regulation

The second point to consider is that the regulatory requirements for depository institutions
whose business models revolve around stablecoins may not need to be severe. This is
because, in contrast to regular banks operating on a fractional reserve regime, there is little
risk and little maturity mismatch in providing only 100 percent-backed stablecoins. In fact,
overly strong regulations could pose their own risks by creating a barrier for entry and
competition in the sector.

The Inessentiality of Central Bank Digital Currencies?
In practice, the Fed already issues a form of CBDC to depository institutions in the form of
central bank deposits, commonly called reserves. This digital money differs from the bank
deposits generally available to the public. Bank deposits for the public are not backed
solely by reserves, but rather a mix of assets bearing different degrees of risk. One could
think of reserves instead as an intermediary good, which produces the bank deposits
available to the public when combined with other assets.
For most smaller depositors — which are protected by deposit insurance — the distinction
between deposits backed by risky assets and reserves is meaningless. Bank deposits are as
good as deposits at the Fed. However, large depositors and depositors skeptical of the
FDIC's ability to provide insurance may still prefer to hold reserves. A natural question,
then, is whether and how to provide depositors with access to reserves. Mechanically, there
are basically two ways:
Directly by creating a CBDC
Indirectly via stablecoins backed by reserves
Let me define CBDC as "essential" if it allows policymakers to achieve a goal that cannot be
achieved with stablecoins backed by reserves. It is challenging to identify such a goal. For
example, if the goal is to make stablecoins exchangeable, that could be done with
regulation. Paying interest on stablecoins could be accomplished by paying interest on the
reserves backing the stablecoins and (assuming entry costs are low) allowing competition to
drive interest rates close to the ones on reserves. The rates paid to reserves backing
stablecoins could even be different than the ones paid on regular bank reserves. As for
making them accessible to a large share of the population, this could be done by
subsidizing or otherwise incentivizing banks to open stablecoin accounts for financially
marginalized households.
There are some concerns with having only stablecoins and no CBDC, but those concerns
could potentially be alleviated with regulation as well. One concern highlighted in the
PWG/FDIC/OCC report, for example, is that a few market participants could end up
controlling the industry due to network effects. While a valid concern, economists have
considered state ownership unnecessary in most industries, with regulation and contracting
taking their place.1

The legislation supported in the aforementioned report would already include a clause
providing the authority to take action to prevent market concentration. And lowering entry
costs by reducing the regulatory burden of banks created solely to issue stablecoins would
likely go in the direction of increasing competition among issuers.
Another concern is data collection, specifically consumers' private information such as their
purchasing behavior. However, authorities could prevent data collection with regulation as
well, and the issuance of CBDC could also require the regulation of wallet providers to
prevent data collection.
The bottom line is that appropriate regulation may offer a path whereby stablecoins
become effectively equivalent to the use of CBDC — when they are issued by regulated
institutions and backed by reserves.

Concluding Comments
As central banks think about both CBDCs and stablecoins, this article argues that there may
be a pathway to create an effective "synthetic" CBDC in the form of stablecoins. More
generally, the discussions around the introduction of CBDCs should always include an
evaluation of the possibility of considering well-regulated stablecoins as a viable (and
possibly preferable) alternative.
Bruno Sultanum is an economist in the Research Department at the Federal Reserve Bank
of Richmond.
Additional Resources
Follow the Series
Are There Compelling Reasons to Consider a Central Bank Digital Currency for the
A Historical Perspective on Digital Currencies
Why Stablecoins Fail: An Economist's Post-Mortem on Terra
Central Bank Digital Currencies and Regulatory Alternatives: the Case for
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Econ Focus, Second Quarter 2022: Fed Eyes Central Bank Digital Currency

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Speaking of the Economy, April 2022: The Fed's Role in Payments Innovation

1 For example, see the 1998 paper "State Versus Private Ownership."

To cite this Economic Brief, please use the following format: Sultanum, Bruno. (July 2022)

"Central Bank Digital Currencies and Regulatory Alternatives: the Case for Stablecoins."
Federal Reserve Bank of Richmond Economic Brief, No. 22-26.
This article may be photocopied or reprinted in its entirety. Please credit the author, source,
and the Federal Reserve Bank of Richmond and include the italicized statement below.
Views expressed in this article are those of the author and not necessarily those of the Federal
Reserve Bank of Richmond or the Federal Reserve System.

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