Digital Currency: coming to a Central Bank near you…
With rapidly digitizing economies and the rise of cryptocurrencies, Central Banks around the world are researching ways to launch their own digital money, commonly referred to as Central Bank Digital Currency (CBDC).
But isn’t most money already digital? Indeed, only around 8% of global money is in paper or coins. However, today’s digital fiat money, locked up in disparate databases and exchanged through dozens of heterogeneous systems, lacks the speed and security of a global blockchain like Bitcoin. It’s still based on the paper-based processes of decades ago. On the other hand, a digital dollar or dirham can certainly compete with Bitcoin as a more stable unit of account and reliable medium of exchange.
To be sure, a main driver of the Central Banks’ interest is a negative one: a defense against dollarization 2.0 as Christine Lagarde of the IMF calls it. States have given Central Banks monopoly over money and the status quo is under threat. Sure, currently Bitcoin’s “market cap” is still tiny (around USD140bn late July 2018), BTC/USD too volatile and the technology is still too early-stage for it to be used as money. However, Bitcoin is in its 10th year now and not going anywhere. Major innovations to cryptocurrency technology will remove issues around speed and network capacity and likely dramatically increase adoption and reduce volatility. CBDC will allow a Central Bank to benefit from blockchain tech without having to rely on anonymous miners (the bookkeepers of Bitcoin) and without having anonymous (or pseudonymous) transactions taking place within its borders. The latter is seen as important to fight crime and terrorism but it also gives authoritarian governments the control to monitor, tax and shut out anyone who doesn’t behave. Already we see that in China people who say the wrong things are unable to buy certain services. Unsurprisingly, China is widely expected to be the first major country to issue CBDC.
The last ten years have proven that quantitative easing and interest rate manipulation are woefully inadequate tools for boosting economic growth. It is very inefficient for a Central Bank to have to rely on commercial banks to carry out policy and issue loans. Banks have been bailed out and have benefited from cheap money ever since, but SMEs, entrepreneurs and the growing army of freelancers are credit lepers. Middle-class purchasing power is decreasing and younger generations are looking forward to a lifetime of debt. Furthermore, with rates now close to zero, Central Banks have their backs against the wall. Direct transfers of CBDC to the public would allow more direct control of money supply. A $1000 of this “helicopter money” could be sent instantly to everyone’s mobile wallet. It could also be targeted to specific groups like SME’s, those willing to settle in underpopulated areas, computer engineering students, or less inspiringly: only to those with a certain “social rating”.
In times of crisis, people take cash money out of banks as they know that banks only have a fraction of the cash available to cover deposits. When doing so they disrupt the free flow of payments and trust in the system evaporates. Central banks, on the other hand, cannot run out of cash. Giving companies and individuals the option to convert deposits into risk-free CBDC eliminates the systemic credit and liquidity risk currently concentrated in large banks. It would also address the moral hazard of the “too big to fail” banks who know that they will be bailed out.
Currently, most payments are run through large banks and their card networks. They act as toll booths on the money highways setting high transactions fees for their smaller rivals and any fintech companies. A CBDC network could break up this oligopoly, allow new entrants and peer to peer payments. Reducing fees for individuals and SMEs.
CBDC can also increase financial inclusion. No more unbanked or underbanked. A free digital wallet (i.e. bank account) on everyone’s mobile phone. This app can be provided by the Central Bank itself or delegated to banks.
A move towards CBDC seems almost inevitable and we have to think carefully how blockchain technologies are redefining money, the financial system and the role of Central Banks. It is clear that CBDC will be an extension of current fiat money, not carry over the global, decentralized aspects of Bitcoin, nor will they allow themselves to be replaced by Bitcoin. As cryptocurrency tech is open-source, nothing stops a Central Bank from adopting parts of it and launch a competing national coin over which they retain monopoly. It’s technically very easy to launch a CBDC on a public network such as Bitcoin or Ethereum, but it would be naive to think that any country would follow this route. Instead, CBDCs will exist on private blockchains operated by the Central Bank and perhaps commercial banks acting as nodes.
Implementing a CBDC can disrupt banks and increase competition, not only with non-bank institutions like payment providers but especially with their own Central Bank. There are various benefits but also a risk that governments will greatly increase their interference in people’s lives. A Black Mirror-style dystopia where a central authority and a social rating determine one’s financial freedom is not far-fetched and it is important for open societies to allow more anonymous cryptocurrencies to co-exist with national digital money.