The Central Banks Plan to Hijack our Blockchain Ecosystem
CBDCs and a review of the finance sector
The banking industry has come under threat of major disruption in the past few years due to the rise of cryptocurrencies. Governments and banking regulators are struggling to contain the creation and use of virtual currencies such as Bitcoin. They have become quite popular and useful in the digital realm thus threatening the need for government issued currencies. Their permissionless, decentralized, and unregulated nature has made cryptocurrencies a natural antithesis to the conventional banking system. Unlike the heavily centralized, regulated, and monitored national currencies, cryptocurrencies are considered to be secure, private, and accessible making them suitable for use outside the purview of authorities. Under the circumstances, and with limited options, nations have been forced to rethink their monetary policies. Innovate NOW or lose control of the national currencies!
The proliferation of virtual currencies, changing payments landscape, and exponential growth of ecommerce are all driving us towards a cashless society. Under such a dispensation, the use of digital currencies is inevitable yet there is a lack of universally viable solutions. The existing options such as cryptocurrencies, e-money, and mobile payments are deeply flawed and with multiple limitations at this time. This has given rise to the demand for legitimate digital currencies with widespread acceptance as legal tender. As such, the idea of creating Central Bank Digital Currencies (CBDCs) has come to the fore in the past few years and is rapidly gaining consensus among national monetary authorities. So much so that the BIS chief warned central banks that they may be required to create digital currencies sooner than was previously anticipated. Subsequently, several central banks globally are considering launching digital currencies. This is in part to counter the rising tide of cryptocurrencies whose growth and influence they have failed to control. As they say; if you can’t beat them, join them.
Governments, are planning to join the blockchain ecosystem and beat them at their own game. It is expected that the creation of CBDCs will initiate a series of developments that can put an end to Bitcoin, cryptocurrencies, and the blockchain ecosystem; the key catalysts for private money. It is expected that most CBDCs will be blockchain-based essentially making them an interesting Bitcoin competitor for a few reasons. CBDCs will possess some of the most important attributes that can guarantee their widespread acceptance; something that has been elusive to Bitcoin and other cryptocurrencies. CBDCs will have governments’ backing, recognition as legal tender, and stability making them more reliable, credible, and legitimate currency. Once they have CBDCs in place governments can put in place and enforce strict punitive measures against the use of cryptocurrencies thus stifling the development of the blockchain ecosystem. In a cashless society users will have limited options thus paving the way for CBDCs dominance. By all means, this will not be smooth sailing but by providing an alternative, the government can finally have a weapon with which to fight back the threat posed by the blockchain ecosystem.
What are CBDCs?
The Central Bank Digital Currencies (CBDCs) will be a digital representation of the national fiat currency to serve as a medium of exchange, a unit of account, and store of value. CBDCs will be issued, operated, and regulated by the respective monetary authority of the specific nation. CBDCs will be backed by national resources, monetary reserves such as gold, and forex thus addressing the price fluctuation problem synonymous with cryptocurrency. CBDCs will combine the security and cost effectiveness of cryptocurrencies with the stability and ubiquity of fiat currency.
Preliminary research and experimentation by central banks has paved the way for launch of national versions of cryptocurrencies by leveraging blockchain technology. A 2018 study conducted by the Bank of International Settlements (BIS) on 63 Central banks in developed and emerging economies revealed that an astounding 70% of these institutions are engaged in digital currency research.
Central bank survey on CBDCs
This is an indication that governments are starting to realize the potential of deploying CBDCs in their economy. As such, nations that are swift to issue CBDCs will benefit from the financial and economic efficiencies of a cashless society in the digital age. So, in regards to the adoption of CBDCs, it is no longer a question of IF but WHEN.
Mapping the progress of CBDCs adoption
To date only a handful of nations have issued state backed digital currencies that are still operational. Tunisia was the first nation to rollout a digital currency, the e-dinar in 2015, complete with an ecosystem that enables payments, money transfers, and remittances through a smartphones. The system also enables the government to monitor the flow of money to aid decision making and inform the monetary policy formulation. Since then several other nations have issued state digital currencies that continue to be used in their local economies. These include Senegal, Singapore, Iran, Peru, Venezuela, The Marshall Islands, Saudi-Arabia and the UAE. Other nations such as China, Thailand, Israel, and Bahamas are either experimenting or in advanced stages of launching CBDCs. The blockchain technology has emerged as the preferred foundation upon which these CBDCs are built due to its features and the benefits they confer. Blockchain technology provides security, transparency, easy public access, real-time settlement, and low costs for the users. From the regulatory standpoint it improves monitoring, accountability, efficiency, and economic data.
What are the motivations of developing CBDCs
Disruption
The rush to develop CBDCs is driven by need rather than want, thanks to disruption. New inventions have transformed the finance, insurance, banking, savings, and investment services by embracing new technological solutions. The invention of blockchain technology, via Bitcoin, has however been the most symptomatic driver of disruption among central banks. This is because blockchain technology allows anyone to create digital money, assets, and exchange value over decentralized platforms without intermediaries such as banks and governments. Given that this has been a preserve of the government these issues have brought significant upheaval in the finance regulatory sphere. This disruption has brought much consternation among governments as their role of controlling the monetary policy is under threat. Suffice to say, the development of CBDCs is driven primarily as a countermeasure to the growth of cryptocurrencies.
Financial inclusion
CBDCs can enhance financial inclusion especially in emerging economies. Over 2 billion people are unbanked as they lack access to banks and internet. This puts them out of reach of conventional banking services. CBDCs can foster economic and social inclusion through the digitization of national currencies and distribution through simple technologies. For instance, Mpesa improved financial inclusion in Kenya through a Sim-based money transfer service.
Efficiency and safety
CBDCs can enhance the efficiency and safety of payment systems and settlements through the consolidation of the banking services providers. CBDCs can help central banks reduce the number of intermediaries by facilitating direct settlement thus raising efficiency. Also, having fewer players in the financial systems will lower risks and increase the speed of transactions. The digital currency would also enable individuals, private organizations, and other financial institutions to make direct settlements via the central bank.
Monetary policy implementation
Central banks can employ new monetary policy tools by shifting from cash to digital currencies. The distribution of digital currencies is easier to monitor and manipulate to achieve the desired impacts on the national economy. For instance, central banks can limit cash distribution to circumvent potential negative interest rate. On the other hand, through effective monitoring central banks can use CBDCs to raise national aggregate demand through helicopter drops to its citizens. These effectively make it easier to stay within the national monetary policy and keeping prices stable.
Cross-border payments
CBDCs can be used to boost the efficiency of cross-border payments and settlements by improving counterparty credit risk. Central banks can rely on the CBDCs to facilitate settlements across markets and financial institutions globally. This would serve to lower credit and settlement risk particularly for large volume transactions and where counterparties are exposed to time lags between nations. CBDCs could also help counterparties to bypass the RTGS infrastructure that requires all commercial interbank obligations to settle.
Motivations for using CBDCs as per BIS Research
Alternative approaches to CBDC implementation
As central banks continue to assess whether to issue CBDCs, there are already established options up for consideration in regards to model, structure, and implementation. One potential approach available to central banks is to issue the digital currency through direct deposit to peoples’ accounts. Under this proposal the central bank assumes the roles of commercial banks by offering the public deposit accounts. People will then be able to transact directly with the central bank and hold its liabilities.
An alternative variation to this solution would see central banks providing banks and other financial institutions with reserve accounts. This would enable them to transact using CBDCs and provide the public with financial services. These institutions are then tasked with handling the customer services such as KYC and AML thus relieving the central banks of such burdening obligations.
Another potential approach would see commercial banks required to have their assets fully backed by central bank reserves. This would effectively end fractional reserve banking which would in turn reduce private credit. As such commercial banks could be forced to borrow their customers’ CBDC to maintain their lending business. Nonetheless, this approach would enhance the financial inclusion efforts whilst lowering systemic risks.
The fourth alternative is a hybrid solution with wholesale and retail CBDC. Retail CBDC would be targeted to the public while wholesale CBDC would be a preserve for financial institutions. The retail CBDC will be used for regular transactions, making payments, and remittances etc. On the other hand, wholesale CBDC would be a value-based currency backed by financial institutions central bank reserves. This will be mainly used to facilitate settlements and institutional payments and helping them to lower counterparty credit and liquidity risks.
Future outlook on CBDC uptake/predictions
I expect that advanced economies will take a different approach to CBDCs implementation from emerging and developing countries; at least based on recent statements made by financial and banking authorities in these nations.
I expect that CBDCs will initially be adopted in emerging and developing countries. This is primarily driven by the need to improve financial inclusion and incorporating more people in the economy. These nations are also more exposed to the threat of private money due to poor structures that risk their financial sovereignty. There is shared enthusiasm about CBDCs among these nations as compared to the advanced economies and it makes sense. They have inadequate banking infrastructure and digital currencies provide a shorter, cheaper, and accessible route for banking the unbanked. Particularly, retail CBDCs will enable everyone to transact and store value electronically without needing a bank account. Furthermore, electronic and mobile payments are common in these economies thus onboarding users and rolling out the digital currencies will be relatively easy.
With that said, I don’t expect implementation and adoption of CBDCs to be smooth in some emerging and developing economies. Assorted problems are expected across jurisdictions with poor governance structures, weak economies, low internet penetration, and volatile currencies. We will also witness catastrophic failures, where nations do not get the right fit for their monetary policy. Similarly, there will be failures abound for knee jerk CBDC adoption under external pressures as evidenced by Venezuela’s Petro failure.
Venezuela’s Petro hyperinflation
There is a lesser likelihood of advanced economies adopting CBDCs in the short term, at least based on statements from their various monetary authorities such as the USA, England, Germany and France. Particularly, a retail CBDC would be of little importance, in the near term as these nations have functional financial systems with most citizens already banked. Thus, Iexpect advanced economies to adopt wholesale CBDCs in the medium term to help boost efficiency in payment and settlement systems. The CBDC technology will be used to link financial institutions and platforms to increase transaction speed and eliminate settlement risk. In the long term wholesale CBDCs will be integral to a global financial infrastructure useful in improving efficiency and security of cross-border payments.
Reimagining finance in a CBDC era/Potential scenarios
No matter the monetary policy taken by central banks, CBDCs are bound to have drastic implications on economies that could leave banks in a precarious state. Banking will undergo fundamental changes with central banks assuming more roles as those of commercial banks shrink. Retail CBDCs will open direct channels between central banks and individuals while wholesale CBDCs offer direct means for payments and settlement. In the very extreme, these changes would render banks redundant and end the banking industry as we know it. However, accommodations have to be made with commercial banks tasked with handling customer management while central banks stick to policy formulation and oversight.
Competition in the banking sector will grow significantly as trust in digital money grows. Banks, fintechs, financial services providers and tech companies will compete for deposits and payment services to the customers’ benefit. However, such competition is not good for their bottom line and partnerships will grow. Mergers, acquisitions, and collaborations will become common as organisations join to build synergies.
Issuance of a retail CBDC would end fractional reserve banking opening up an opportunity for people to lend their deposits to commercial banks to facilitate their credit services. This would also open up a market for CBDC-based peer to peer and decentralized financial (DeFi) products. These products will act as both competition for the Ethereum-based DeFi products and a boost to the rapidly growing segment. Total value of DeFi protocols has grown from $181 million to more than $500 million between July 2018 and July 2019. As the role of commercial banks diminishes under CBDCs, inventions such as DeFi will gain a foothold in the finance sector to provide alternative access to private credit.
Ethereum’s DeFi ecosystem
CBDCs will also have profound effects on the blockchain ecosystem as their development is largely a countermeasure to the proliferation of cryptocurrencies. Proper implementation of CBDCs could eventually end Bitcoin and the private blockchain ecosystem. CBDCs possess similar attributes and serve similar purposes to cryptocurrencies and come with less baggage. This will however be a difficult task as pushback from the cryptocurrency community, private organizations, and the public is expected as privacy issues and financial surveillance concerns will grow in a cashless society.
Conclusion
CBDCs present a novel approach to banking with the potential to transform the financial sector in unimaginable ways whilst countering the threat posed by Bitcoin and other cryptocurrencies. As the world gears up towards a cashless economy, digital currencies are inevitable and as such central banks will be stepping in and offering more legitimate solutions in a space that increasingly dominated by private money.
Central banks should however proceed with caution as the potential disruption of the banking infrastructure could have adverse effects on the national economy. Inasmuch as it promises exciting gains, especially at the individual level, a massive overhaul of the sector may lead to financial instability. Reduction in private credit, loss of jobs, income inequality, and disparity between savings and investments could result from a poorly designed CBDC rollout. Is this a price governments are willing and ready to pay? Just to get rid of Bitcoin and the blockchain ecosystem. I think the answer is yes. Why? Governments are not particularly known for rational and measured responses especially when their sovereignty is at stake. So, yes, they are coming for your Bitcoin and our beloved blockchain ecosystem. The idea of CBDCs is too far advanced to imagine a potential turnaround at this time.
Central banks have played on the sidelines for far too long in the digital money space but now they appear keen to take center stage and will not go home without a fight. Another form of competition is coming for our beloved blockchain ecosystem. The future looks bright for us in blockchain without these Central Bank Digital Currencies… but understand this, the banks are coming for us and they still have the masses.
About the writer
Edwin is a naturally curious person with a deep interest in new tech. He has been involved in multiple cryptocurrency projects providing blockchain knowhow, technical, and marketing support. He co-founded coinweez, a website dedicated to creating awareness about blockchain technology in Africa.
