New on FinoLib · Volume II: Capital Markets
I have added a new article to FinoLib, my finance education website: CBDCs and DeFi Explained: Real Innovations vs Real Risks, part of Volume II: Capital Markets. This page gives you the core of the topic in expert but plain language; the full article goes much deeper.
11.5 CBDCs — What They’d Actually Change
The idea in plain words
A central bank digital currency, or CBDC, is a direct digital IOU from the central bank, as safe as cash. Its main risk is faster bank runs, because people could move money out of banks with a tap. Designers limit that with holding caps, zero interest and distribution through banks. The US has barred work on one, while the euro area may issue a digital euro in 2029.
Key points
■SVB lost over $40 billion of deposits in one day in 2023 without any CBDC.
■A $3,000 limit caps outflow from a bank with 1 million customers at $3 billion, 25% of $12 billion in deposits.
■Executive Order 14178 (January 23, 2025) bars US agencies from establishing or promoting a CBDC.
A closer look
Volume I named Central Bank Digital Currencies (CBDCs) without detailing what they would actually change relative to money that already exists digitally today. The key distinction: money in a normal bank account is a liability of a commercial bank — a promise from that bank to pay you, which is why deposit insurance and bank regulation (Volume I’s Part 3) exist at all. A CBDC would instead be a direct liability of the central bank itself — functionally identical in legal status to physical cash, but held and transacted digitally.
Decision rule
Judge any CBDC proposal on three parameters before its technology. If the holding limit is near a few weeks of household spending, the CBDC pays no interest and banks distribute it (two-tier), deposit flight is bounded and bank lending largely unaffected. If the limit is high or absent and it pays interest close to policy rates, expect banks to lose stable funding and raise deposit rates or shrink lending.
The costliest mistake
Launching a retail CBDC without a binding holding limit. In the worked example the unlimited design leaves all $12 billion of deposits runnable into central bank money, against $3 billion with a $3,000 limit: $9 billion of extra runnable funding the bank must cover with low-yielding liquid assets or replace at higher cost. SVB’s 85% run happened without a CBDC; removing the remaining friction without a limit invites a faster one.
11.6 DeFi — Real Innovations vs Real Risks
The idea in plain words
DeFi, or decentralized finance, rebuilds trading and lending with smart contracts instead of banks. An automated market maker sets prices from the amounts in a pool of tokens. People who supply tokens earn fees but can suffer impermanent loss when prices move. Lending protocols watch a number called the health factor and liquidate a borrower automatically when it falls below 1.
Key points
■A 100,000 USDC buy in a 1,000 ETH pool pays an average $2,106, 5.3% above the $2,000 mid price.
■Impermanent loss = 1 − 2√r ÷ (1 + r): 5.72% if the price ratio doubles, 20% if it quadruples.
■Health factor = collateral × liquidation threshold ÷ debt; the cushion before liquidation is 1 − 1 ÷ HF.
A closer look
Decentralized finance (DeFi) uses smart contracts to recreate financial services such as lending, borrowing and trading without a bank, broker or exchange as intermediary. Its innovations are real: a decentralized exchange (DEX) can price trades with a formula, an automated market maker, instead of an order book run by an operator, and DeFi lending protocols match borrowers and lenders directly, with collateral rules enforced by code rather than a loan officer’s judgment.
Decision rule
Borrowing against volatile collateral: keep the health factor at or above 1.5, which survives a 1 − 1 ÷ 1.5 = 33% fall in the collateral, and add collateral rather than waiting when it drops toward 1.25 (a 20% cushion). Providing liquidity: do it only where expected fees over your holding period exceed the impermanent loss of a plausible move, 5.7% if the pair’s price ratio doubles or halves.
The costliest mistake
Borrowing to the edge. At a health factor of 1.10 a 9.1% fall in ether triggers liquidation, a move volatile crypto assets can make within days. In the example a liquidator repays $7,500 (half of the $15,000 debt) and takes $7,500 × 1.05 = $7,875 of ether, so the borrower loses a $375 bonus on top of having half the position sold at the low, and the ether seized cannot recover if the price rebounds. The cheaper choice is to borrow less: at $12,000 the same fall would have left the loan untouched.
What the full article covers
In the full article I take you through these sections:
■11.5 CBDCs — What They’d Actually Change
■11.6 DeFi — Real Innovations vs Real Risks
It includes a look under the hood at the mechanics, a clear decision rule, the one mistake that costs people the most, a recap, a reveal-on-click quiz and the official sources behind every figure.
Volume II: Capital Markets
Read the full article on FinoLib
The complete article, CBDCs and DeFi Explained: Real Innovations vs Real Risks, with every worked example, diagram, quiz and source, is free to read in Volume II, Capital Markets on finolib.com.
Explore the Finance Education Series: Vol. II — Capital Markets · Vol. I — Global Economy · Vol. III — Finance Encyclopedia · Vol. IV — Finance Careers · Vol. V — Personal Finance