Money is a complex construct consisting of public and private elements. It is not all coined or printed by a government; a significant portion originates with private-sector entities like banks, against which other private parties have contractual claims. In a forthcoming article, we examine the continuing coexistence of private and public money in the advent of digital-asset innovations such as stablecoins and central bank digital currencies (CBDCs).

Over the centuries, federal law has specified which firms issue the safest private money and, in doing so, has placed private banks in a somewhat privileged position. Namely, the Federal Reserve (the “Fed”) sits atop our monetary system, managing the markets through monetary policy tools such as open-market operations, bank reserve requirements, and discount window lending. Within this system, banks “bundle” lending, payments, and deposit-taking in their business models, comply with extensive regulation, and are protected by high regulatory barriers to entry. What makes them safer are the deposit insurance system and a special regime called “resolution” of troubled banks. Other financial firms do not have access to either.

Nor do other financial firms have access to the Fed-provided rails of the U.S. clearing and settlement system for inter-bank payments and the master accounts at the Fed. The rest of the private institutions within our complex money system effectively depend on banks to provide them with access to the clearing and settlement system.

These regulatory fundamentals of the private-public economic partnership are long-standing but imperfect. For one thing, we periodically see how various regulated financial intermediaries fail: It happened during the financial crisis of 2008 and when several midsize banks failed in 2023. Banks also have flaws in their operational coverage and do not serve every part of our economy: There are millions of unbanked and underbanked residents in the United States. Another crucial set of problems arises in payment systems, which exhibit inefficiencies and high costs in payment transfers, clearing, and settlement.

The traditional avenue for improving efficiencies and reducing transaction costs is innovation accompanied by relevant regulatory changes that ensure that innovations do not generate negative externalities affecting consumers, financial markets, and the economy But what are the best ways to apply and control private innovation’s negative externalities through regulation? And which parties within the public-private monetary system are best positioned to innovate, and how should they interact under changing rules?

In our article, we consider these questions as applied to two technology-based initiatives: CBDCs (digital money designed as a representation of fiat money with universal accessibility and the status of a legal tender) and stablecoins (privately issued cryptoassets relying on blockchain technology and aiming to maintain stable value, often through collateralization by other assets that have intrinsic value). These public and private innovations are often presented as a study in contrast and competing products, with stablecoins described as being risky to users and the economy, raising systemic risk concerns, and threatening monetary policy and sovereignty, among other problems.

We underscore the need for a continuing coexistence of private and public money in the new digital world and identify the pros and cons of the relationship between stablecoins and CBDCs. The United States is unlike many other countries in its historical approach to public monetary sovereignty and the importance of private money and financial institutions. The public does not need to oust the private. Instead, carefully regulated private initiatives should be preserved lest the United States lose the efficiencies of private innovation. The task, however, calls for a balancing act to create adequate regulatory guardrails. Stablecoins have the potential to enhance efficiencies in payments through instantaneous settlement. Technology may create financial services and payment instruments that are more accessible and affordable. Yet innovations also may generate risks to financial stability, market integrity, and consumer welfare. An effective stablecoin regulation should consider the plurality of business models and adopt a risk-based regulatory approach. The goal is to balance innovation and risk management, ensuring the coexistence of stablecoins and CBDCs, which could foster a more resilient and competitive payment system globally. Such a regulatory approach should also safeguard state interests while addressing payment system inefficiencies, potentially offering a new model for the coexistence of public and private money forms.

A related question is how to improve this public-private partnership. Can conventional banks, as the traditional source of safe private money, innovate as rapidly and effectively as younger and smaller firms? And would the regulatory pressure on banks force them to innovate in a direction chosen by the regulators? Moreover, can governments issue CBDCs and make stablecoins, their purported rivals, irrelevant by providing a superior product? We suggest that neither the conventional banks (as the major and entrenched source of private money) nor central banks (as the source of public money) have sufficient incentives and capacity to innovate adequately. Established and conservative firms are slower to innovate and abandon old approaches and products compared with nimbler newcomers, and the government has never been the optimal source of innovation.

Our exploration into the coexistence of stablecoins and CBDCs reveals a complex and evolving landscape of technological innovation in the payment and financial sectors. We underscore the need for a nuanced understanding of both private and public digital money, highlighting their distinct roles, potential benefits, and inherent risks within the global financial system. While stablecoins offer innovative solutions and contribute to diversification within the financial and payment sectors, their regulatory challenges and risk factors necessitate careful oversight. Conversely, the emergence of CBDCs represents a significant step by central banks in modernizing monetary systems and potentially enhancing financial inclusion, but these developments raise their own sets of challenges and risks.

A key overarching observation is that public money, including CBDCs, and private money, such as stablecoins, will continue to coexist. Regulators need to adapt to this evolving coexistence and plurality of monetary instruments and create reliable regulatory safeguards for this public-private economic partnership. Better, smarter guardrails for the evolving coexistence of private and public money must simultaneously capitalize on the benefits of private innovation, control its negative externalities, safeguard financial stability, and protect consumers. This way, we will have a chance to use the advantages of having both public and private money to solve the longstanding problems of payment inefficiencies and financial inclusion. By contrast, entrenching the status quo and preserving the current regulatory and payment models could cause us to miss an opportunity to address the inefficiencies of the existing system.

This post comes to us from Yuliya Guseva at Rutgers Law School, Sangita Gazi at Rutgers Law School and the University of Hong Kong, and Douglas Eakeley at Rutgers Law School. It is based on their recent article, “On the Coexistence of Stablecoins and Central Bank Digital Currencies,” available here.