Stablecoins and CBDCs could take fractional reserve banking to a whole new level - the good and bad

Isn't it fascinating how it is becoming increasingly difficult to distinguish between stablecoins and CBDCs?

Well, the idea is simply to make it as complicated as the financial system has always been, so while one wishes to tell apart what stablecoins are and what they are not(CBDCs), you'd figure that there are closely the same thing - with one difference of course.

A quick dive into stablecoins exposes us to the different types that they are - centralized stablecoins and decentralized stablecoins.

What makes one different from the other is simply the protocols(rules) that govern them.

Centralized stablecoins are often governed by a concentrated body of issuers that controls the flow of these assets and the custody thereof.

An example is Tether. Tether controls the flow of USDT, it can freeze any amount in circulation as it wishes because USDT isn't autonomously functioning, there are not smart contracts free from a central control, every USDT in circulation can be frozen by Tether.

This isn't to say it isn't powered by "smart contracts" this is one other misconceptions we have as crypto enthusiasts, the believe that "all smart contracts" are autonomous contracts that acts or functions independent of human control, that is false, the USDT smart contract is not autonomous, this allows Tether to take certain actions on all USDT in circulation.

That said, when we roll the stone towards "decentralized stablecoins", the concept of "smart and autonomous contracts" comes into play.

An example here would be algorithmic stablecoins like HBD. The creation and removal from "accessible supply" of it isn't controlled by a company like Tether, but simply by code that is only adjustable by the consensus of the network participants.

In the case of Hive and HBD, this is the witnesses, who are voted in by the Hive holders community.

CBDCs as stablecoins

Now, having known the difference between centralized and decentralized stablecoins, where do CBDCs fall into? Are there really stablecoins? Or a volatile cryptocurrency?

CBDCs are stablecoins, centralized stablecoins to be exact, they mirror the value of the underlying currency like the Chinese Yuan and I urge that nobody uses them as the risks are enormous - but of course, it is but a theory and not financial advice.

When you read up a bit on federal reserve banking, you'd understand why the acts of the traditional banking system venturing into crypto via tokenization of real world assets and deployment of CBDCs can expand the economies to an overheat situation.

Money has evolved over the years, it is no longer just fiat currencies, it is not only gold or any other precious metals, money is the definitive representation of value, meaning that it can be placed into anything.

Stocks, bonds, mutual funds, crypto assets, you name it, the list goes on.

But the problem here is that the more expansive it becomes, the more dangerous it gets. You see, in theory, everyone says that what devalues a currency is money printing, while that is true, it is a half-baked reality of what causes the devaluation of money - inflation.

Money isn't physically printed all the time, so while money printing causes inflation, the process isn't always physical, fractional reserve banking facilitates the act of printing virtual money.

When money can exist in so many forms at once, some become empty vessels with virtual values that are not backed by anything.

Here's an example.

Person A deposits $100,000 in a bank, the bank, following the fractional reserve banking principles, holds on to say $30,000(30%) and loans out $70,000(70%) to Person B.

This means the bank virtually holds $170,000 now, where $140,000 is virtual and only $30,000 is the real cash at reserve. Only if the person pays back this loan does the $70K which was created out of thin air gets eliminated, balancing back the figures.

Moving forward, now Person B goes on to use that $70,000 to purchase a stock, as weird as it may sound, that adds a floating debt of $70,000, although this is not the banks' debt just yet, but it could become one if the stock value falls to zero, meaning that $70,000 virtual debts has been added to the bank because the person wouldn't be able to pay back, bringing the total to $240,000.

Of course, this explanation ignores the collaterals placed in the possession of the banks/protocols mentioned in this article for the sake of clarity.

If the seller of the stock decided to take that $70,000 and deposit it in the same bank, that would bring the total virtual value to what?

$310,000. Now the funny thing here is that the bank can loan another $70,000, expanding the supply even more.

And it doesn't end there.

With CBDCs coming into picture, the bank with all the circling back values could issue CBDCs that mirrors these virtual balances of theirs, whether or not this excludes the debts, we cannot tell, but this simply puts the fractional reserve banking on a whole new level, allowing increased expansion of the fiat money supply - which are effectively backed by nothing - the fun part as always.

This is why many believe the US Dollars is always going to be the most powerful unit of account and currency, given the increased merits of its derivatives.

So say Person C takes a CBDCs credit and deposits cash. Uses that CBDC to buy cryptocurrency, adding yet another floating debt, now, he deposits the crypto in a protocol, takes out a loan, adding another floating debt, uses this debt in a risky investment to yield interest so as pay back the loan to the protocol - whether or not he succeeds cannot be known from the beginning.

Let's not forget the Person B that bought a stock worth $70,000. With banks like JPMorgan delving into crypto with tokenized traditional assets, Person B could deposit the stock with JPMorgan, receiving a tokenized version, adding yet another floating debt, which he uses to buy crypto, deposit in a protocol to take out a loan, just as person C, adding another floating debt.

You'd notice that at the benefits of an expansive economy is a very dangerous financial crisis roaming around due to the unbacked nature of bank loans.

Although not everyone that takes a loan will do exactly at stated here, but it doesn't change the fact that we are in a world of investments, there's bound to be some similarities of actions taken by the industry and once the effects sets it, we begin to see these institutions experiencing bank runs and closing their doors.

But of course, all the floating debts goes away if the persons involved in these investment transactions are successful, but what are the chances the majority will be?

What is the solution?

It's simple in theory - Distributed and decentralized governance.

Everything ever created within the walls of the traditional banking system has its merits, fractional reserve banking helps in economic expansion, that's the truth, but the governance structures do not allow effective and broadly beneficial changes to be made on time.

Distributed and decentralized governance will help mitigate the risk involved with allowing a central body to decide when the damage is too much and steps should be taken to curb it.

Without the deployment of these consensus structures for financial systems, a crisis beyond measure sleeps at the mat of the front door - run from CBDCs, centralized stablecoins and government issued tokenized assets.

If you're not already an addict to them, that's to say.