Central bank digital currency — why it did not happen yet?
Making money all-digital may be a way for governments to catch up with the digitization of the world and improve the lives of citizens. However such projects have problems going further than the concept stage. More trust from the market and a proper technology is needed for this to change in the coming years.
Imagine that you can store money in an app like you would do in a physical wallet. You can use it to pay online or in physical stores, exchange funds between friends and family or accumulate savings. Sure, you can usually do such things with mobile banking. This is however more than a banking app — and in fact you do not need even a bank account to use it.
Here money is not an entry in a banking ledger but it is stored directly on your device. You, not a bank, are its unique owner. Every piece of it has a denomination and a serial number — just like banknotes. Payments are made instantly, just like with cash in hand. Even better than in mobile banking, there are no fees — open or hidden — for using it.
Sounds tempting? Well, you cannot use such app yet to buy bread and veggies, but things may change with the introduction of the central bank digital currency (CBDC). For many this new digitised form of money would complement or even replace cash in a daily life of millions of people. There is so far no exact definition of CBDC (also known as a sovereign digital money), but it can be loosely characterized as a widely available digital liability, issued by a central bank. This is not a cryptocurrency — money stored and exchanged that way is not a crypto token, but a regulated currency. This is also not a bank account entry, but a fiat money — central banks create it under their monopoly to issue legal tender, as they usually do with coins and banknotes.
From this common root branched different ideas how to launch that concept in the real life. CBDC could operate as a centralized system, with a central bank keeping accounts and verifying transactions, or use distributed ledger for automatic verification by transaction parties. Its value can be stable (like cash), indexed against inflation or it can bear a certain interest rate (like money in a bank account). And finally, it can be available only for settlements between central bank and commercial banks or presented directly to citizens, either by a central bank itself or providers — commercial banks or e-money institutions — with a proper license.
The concept of switching from coins and paper money to CBDC has obvious benefits. Digital money is arguably safer and easier to distribute than physical cash. It can empower 2.5 billion people underserved by the current financial system — young people, migrants or nations of the Global South — who could access universal bank accounts provided for free. Further, removing intermediaries, like banks or card institutions, from the payment process would practically eliminate payment transactions costs for small businesses and consumers, with accompanying productivity benefits similar to those of a tax cut.
Electronic currency replacing cash would be furthermore helpful in discouraging tax evasion, money laundering, and other illegal activities. As a regulated alternative, it would make cryptocurrencies less attractive, and in turn benefit the stability and transparency of the financial system. It would be also a new channel of monetary policy, allowing central banks to control money supply more directly than with interest rates or quantitative easing. In an event of a serious economic downturn a central bank could just transfer more electronic money directly to citizens, as a stimulus to increase their purchasing power.
The feasibility and desirability of central banks issuing digital versions of their currencies has been the focus of a growing debate in recent years, parallel to the development of cryptocurrencies. As blockchain delivers a tamper-proof record of transactions, the underlying distributed ledger technology (DLT) became the most promising architecture. As the crypto bubble grew, so did the interest in digital currencies, with numerous central banks producing research papers on their possible introduction (Canada, Finland, New Zealand, Norway and UK to name a few). However, when bitcoin price fell, so waned the CBDC hype, especially in Europe. In a recent letter to the European Parliament, the president of the European Central Bank, Mario Draghi stated that ECB has “no plans” to issue a digital euro. According to Draghi, cash and bank accounts already satisfy the needs of EU citizens, and the technology for digital currencies remains unproven. Individual EU countries also remain careful. Germany’s Finance Ministry dismissed this ideas, as digital currency would have “not well understood risks”.
Estonia, the forerunner of digital transformation, scaled back its EstCoin plans from currency to merely electronic signature, after having been pressured by the ECB. In Poland, the idea of Digital PLN, advocated by the Ministry of Digital Affairs, did not live even a day, having been stricken instantly by the Polish central bank. Sweden, world’s leading cashless nation, is mulling the introduction of e-krona, saying it is time for a pilot project, but so far neither a detailed plan nor dates are given. In addition, the union of Swedish banks warns against creating it, as it would give Riksbank unfair advantage over them.
Outside Europe things move at a various pace. On the one hand Australia and New Zealand rule out the introduction of CBDC for now, quoting challenges in finding the right technology. The same goes with Hong Kong, which authorities after some initial research decided to shelve the idea. On the other hand, central banks of China, India and Thailand has announced in recent months research projects investigating the viability of such assets. In Japan, where cash is still king, tech companies embrace blockchain to deliver digital yen, but first they need to convince the Bank of Japan, which still has reservations about that proposal.
The most advanced example of a government embracing sovereign digital currency is Venezuela. Its national token, petro, was introduced not just as a CBDC, but as a second national currency, next to bolivar, with the exchange rate pegged to the price of Venezuelan oil. Petro is supposed to be used for international settlements and, according to the government’s promises, public sector employees would also be paid in that currency. Iran comes next, with plans to launch a digital currency to bypass US sanctions. However, attempts to create sovereign digital currencies by autocratic regimes does not add credibility neither to this concept, nor to the underlying DLT technology. Petro’s ICO ended with a disgrace, as investors have not yet received their tokens, and sanctions would probably bar a wider usage of those currencies. A small Pacific nation of Marshall Islands also pursues plans to launch its own digital currency, but is pressured by the International Monetary Fund to abandon them.
If sovereign digital currencies are so cool, why they did not yet get traction? First, they have strong opponents in the banking sector. Indeed, a report by the Bank of International Settlements from March warned governments against launching CBDC as it would undermine the stability of the financial system.Central banks providing free accounts to citizens would offer a risk-free alternative to bank deposits — countries, unlike private banks, cannot go bust — bank customers might switch to central bank money. As funds would be pulled from the private banking system, interest rates would rise and a risk of bank runs could further grow. This could form a vicious circle, draining money out of private banks until their liquidity is threatened. For many liberal-minded economists, a central bank as a equal actor on the bank accounts and deposits field would be too radical state intervention on the market (but it’s worth sauing here central banks also were a big change itself which met with opposition).
Governments would also need to find a proper technology. I would give a detailed explanation in another article, but for now it is enough to say public blockchains powering cryptocurrencies are too slow and not scalable enough to handle the level of transactions done today with bank account money. While relying on P2P transfers would be free, other form of electronic money would also require setting up a new infrastructure necessary to power it, with so far unknown costs. If a digital money would at some point replace a familiar cash, some citizens — elderly or less tech-savvy — could find it hard to adjust.
Given those considerations, several things must happen to see sovereign digital currencies widely implemented. Central banks must lend their support which can take a lot of convincing, given they have generally been renowned as conservative institutions. Private banks and commercial institutions must be appeased that sovereign digital money would not harm their businesses. This may be done by introducing a proper model of using that money, e.g. granting them the business opportunity to run CBDC-powered light bank accounts. But perhaps the most important thing is presenting the right technology: scalable, fast and able to compete with the throughput of current payment systems. Numerous such designs exist now on paper, but the one thing which will work is providing proven, working business deployments which give value.