ECON120 Study Guide

Unit 7: Cryptocurrencies, Stablecoins, and Central Bank Digital Currencies (2013–Present)

7a. Outline the goals and functions of stablecoins and alternative cryptocurrencies

  • Why did alternative cryptocurrencies emerge in the years after Bitcoin's formation?
  • How are alternative cryptocurrencies treated in their price relationship with Bitcoin on cryptocurrency exchanges?
  • What does a stablecoin attempt to accomplish?
  • Why were stablecoins originally demanded?
  • How does a stablecoin fall into the layers of money?
  • How are stablecoins and cryptocurrencies evolving in the regulatory landscape in the US?

Many alternative versions of cryptocurrency to Bitcoin have emerged. They exist on a lower layer within the BTC money pyramid due to a price relationship, much like national currencies existed on a layer below the dollar after the Bretton Woods agreement of 1944. Like the USD acts as the base price for currencies from around the world, BTC acts as a base price for many digital currencies.
Stablecoins are liabilities issued as digital tokens by private sector companies. They are supposed to trade at a "stable" value relative to dollars. However, they rarely possess enduring stability. Stablecoins were invented because exchanges needed an easier and quicker way for customers to convert between BTC and USD. In essence, exchanges create cryptocurrencies representing USD in a bank account but transacted with private keys and addresses like Bitcoin. In January 2021, the US Treasury approved stablecoins for banks to digitally transact value as long as banking laws are followed.
To review, see Alternative Cryptocurrencies, Stablecoins, and CBDCs.

7b. Identify the origin of central bank digital currencies (CBDCs)

  • How does a central bank's digital currency differ from traditional currency?
  • What are the motivations behind CBDCs?
  • How do CBDCs differ from Bitcoin?
  • How might governments use CBDCs to enact fiscal policy?

In 2016 a senior Bank of England official argued that central banks could use token-based digital cash like Bitcoin to their benefit by widening access to who could hold central bank liabilities, or second-layer money.
With a CBDC, the Federal Reserve can issue second-layer money directly to people. The Federal Reserve wouldn't necessarily be able to provide this type of economic stimulus without political debate; a CBDC blurs the line between the central bank's independent monetary policy and government-controlled fiscal policy.
To review, see Alternative Cryptocurrencies, Stablecoins, and CBDCs.

7c. Distinguish between retail and wholesale CBDCs

  • How do retail-facing CBDCs compare to paper cash issued by central banks?
  • How would a wholesale-facing CBDC compare to Fed reserves?
  • What is the difference between a retail CBDC and a wholesale CBDC?

So far, CBDCs are unchartered. From a layered-money perspective however, CBDCs are more defined. When issued by a central bank, digital currency will be second-layer money (a liability on the central bank's balance sheet alongside cash notes and reserves). Central banks first have to decide which liability they want their digital currencies to emulate more: wholesale reserves or retail cash.
When people use cash, they use second-layer money and avoid the banking layer altogether. But most people use bank deposits and payment platforms linked to bank accounts for their daily interaction with money, which occurs in the third and lower layers. With CBDCs, governments might reduce the role of banks in the issuance of money. Alternatively, central banks could issue a digital currency as wholesale reserves, which would only be accessible to banks.
To review, see Alternative Cryptocurrencies, Stablecoins, and CBDCs.

7d. Predict how Bitcoin, cryptocurrencies, stablecoins, and CBDCs may change the international monetary system

  • How could Bitcoin evolve in its monetary role?
  • How could distributed ledger technology affect the international monetary system?
  • How could stablecoins function in the future?
  • How could the relationship between central banking and private sector banking evolve after the introduction of CBDCs?

​​An atomic swap is a smart contract that allows for the trade between digital currencies without using a third-party exchange. They are programmed to execute the trade for both parties or neither, which attempts to eliminate counterparty, exchange, and default risk. Atomic swaps will only work on central bank digital currencies. However, this doesn't necessarily mean that a central bank issuing a CBDC on a distributed ledger would cede any control over the underlying currency.
To review, see The Potential Future of the Monetary System.

Unit 7 Vocabulary

This vocabulary list includes terms you will need to know to successfully complete the final exam.

  • atomic swap
  • stablecoins