Faced with Facebook’s attempt to launch the first global stablecoin (GSC) with Libra, central banks are maneuvering to avoid the monetary disorder that the regulatory vacuum can create and simultaneously short-circuit the risks that it entails for financial stability, for the competition and for the economic system itself.
Generally unknown to the public due to the complexity of their activities, never have central banks been so communicative in their positions and explanations about their role in society and especially in the functioning of payments. There are three lines of action that central banks are developing:
- How to regulate new activities and participants
2. How to improve current retail payment systems
3. Exploring the launch of Central Bank Digital Currencies (CBDC)
CBDCs represent digital money issued directly by a central bank without the mediation of commercial banks, when precisely these create “bank money” through credit. CBDCs are the nuclear option of central banks to the arrival of technology in the strategic and sensitive world of money.
Precisely the Bank of International Settlements (BIS), the bank of the central banks of the world announced the creation of its Innovation Hub and has appointed Benoit Couré, a heavyweight in the sector and member of the ECB executive board. Couré himself has called Libra “the elephant in the sandbox.”
The central theme of the BIS in its numerous analysis of new digital currencies and modern means of payment, and that justifies that the early intervention of monetary regulators is precisely that legal tender money is a public good and cannot be threatened the by private initiatives of GSCs. Especially when digital coins like Libra are launched by someone like Facebook with more than 2400 million users worldwide.
“Money” is thus a social convention for the communities that make up the countries and its functioning is based on the institutional surveillance carried out by central banks as bodies that emanate from the laws and sovereign states that ensure the public interest.
The role of central banks avoids conflicts of interest, as it can happen with private money issuers such as Libra. The Libra Association intends to govern from the issuance and withdrawal of currency, the control of part of the payment infrastructure and storage of money that would result from the circulation of Libra through technological networks outside the control of central banks and their supervised commercial banks. The Libra Association could pursue a commercial interest directly or indirectly for its associates.
Money understood as a means of mass legal payment is therefore a public good that needs an infrastructure that only central banks can and have legitimacy to provide.
Central banks are a centerpiece of the current money network but their existence is relatively recent and their merit has been to evolve from token money (objects with which the bearer is paid) to the account-based money (paid to whom is identified as holder). This second money, also called claim based, gives rise to the expansion of confidence in an increasingly global money reaching the dollar and today’s fiat currencies.
The genesis of what may have been the first central bank in the world that used a stablecoin concept was the Amsterdamsche Wisselbank (Bank of Amsterdam) only three centuries ago. The Bank of Amsterdam issued certificates of deposit backed by precious metals and the transit of certificates began to allow payments and credit on accounts at the Bank of Amsterdam, resulting in a burgeoning banking and commercial economy. However, it ended up going bankrupt for financing to the Dutch East India Company in 1795, which is why today the oldest active central bank is the Swedish Riskbank instead of the Dutch central bank.
Central banks today have learned that good governance, consisting of avoiding conflicts of interest (independence) and having clear objectives, is essential to build confidence in the currency.
Central banks today:
1. Provide a unit of account of the monetary system of a country. Thus, a dollar bill represents a promise of payment by the US Federal Reserve. Based on this basic promise, the rest of the promises that make money work as a lubricant in the economy are built. Central banks issue analog money token.
2. They make all payments made in the economy to finalize in their accounts. In the current situation, money works in a system with two levels. At the first level, central banks open accounts for commercial banks (account based wholesale money). In these accounts the wholesale payment systems of the central banks settle the payments between the commercial banks. In the second level, commercial banks open accounts for individual and corporate clients (account based retail money) that move money between banks, but through their accounts at the central bank.
3. They provide liquidity of last resort, since the balances of the commercial bank accounts in the central banks are much smaller than the size of the payments in which they intervene and although they are settled on the same day there is a high volume of intraday risk that is controlled with collateral guarantees that banks deposit in the central bank.
4. Supervise private payment systems so that they function properly.
The point is that a) in underdeveloped countries cross-border payments are expensive and banking is not efficient or does not offer banking services (reason argued by Facebook to launch its Libra proposal), or b) that in developed countries BigTechs and global card issuers have been decisively introduced in online and point of sale payments.
Despite the evolution of wholesale payment systems (RTGS), commercial banks have been slower in the development of retail payments and their solutions in any case are national, so that little can be done to compete in equality against companies Global technology
The BIS argues that CBDCs are the best possible stablecoins since they can be converted into money from the country’s central bank. The rest of the private sector’s stablecoins can generate losses for the holders due to the price variation when they convert back to the central bank’s money. Although it is also true that the continued global monetary expansion somewhat resembles the degradation of the value of the old currencies when the precious metals enmeshed in them began to be scarce although their monetary value remained the same (currency debasement).
The way to solve these problems is to use technology as a lever to improve payments, particularly blockchain-based solutions or in general decentralized finance (DeFi). While a wholesale CBDC (digital wholesale money) can replace a commercial bank account at the central bank and therefore represents a more natural and harmless step (many central banks are exploring wholesale CBDC projects such as the Bank of Canada and Monetary Authority of Singapore, or the Banque de France that has just announced that it will explore a wholesale e-euro for French banks), a more critical step would be for central banks to decide to launch a retail CBDC (digital retail money) aimed at the public usually.
It is very likely that blockchain technology will continue to improve to accommodate the number of operations (scalability) that are performed today through centralized payment systems. In particular, it is possible that one of their fundamental problems is solved today: to implement consensus algorithms and validation of operations (mined) sufficiently robust and simultaneously economic in public blockchains. One of the main criticisms of non-public blockchain systems is that they are similar to traditional payment systems as long as there is a controlling authority. However, the possibility of chaining associated automatic events through smart contracts gives blockchains an unparalleled advantage. It could even allow liquidation in the accounts of central banks with much less need for intraday loans, freeing up a huge amount of resources in commercial banks. Therefore, payments could be finalists within the blockchain whether or not it is controlled by the central bank. The confidence that exists today in the institutions that today are the central banks would be strengthened and made more efficient through technology.
Clearly the preference of central banks is the continuity at least in the short term of the current two-tier system because it is known and because its disappearance would be very traumatic not only for the banking sector but for the continuation of activities such as money creation that today the banks do and that would have to be orchestrated around the central banks. It would be necessary to see who performs the identification of the clients (KYC), the controls anti money laundering (AML), the profiling of risks and suitability, tasks that the banks do today. Today customers are indirectly anonymous except in transactions with banknotes and coins, as in practice any central bank can request the data from its supervised commercial banks. But it is clear that if customers had direct accounts at the central bank, the control of the states would be easier.
This two-tier system is the one that seems to be maintained with the launch of the next digital currency that the Chinese central bank will presumably issue. Chinese commercial banks will distribute a retail CBDC through a specially dedicated and created state retail payment settlement system called NetsUnion Clearing. Something similar seems to happen with the initiative of the Swedish central bank Riskbank to launch a retail CBDC supported by private initiatives such as Swish to improve the retail customer experience in digital wallets or e-wallets, an area until now exclusive to commercial banking. A group of 20 European banks are working on a retail payment initiative (Paneuropean Payment System Initiative — PEPSI) that allows for a pan-European option in the face of the growing dominance of US cards and large technology.
The challenge of central banks is therefore multiple:
• Understand the new models and the risks they pose for the system and its function.
• Ensure that models such as GSCs do not expand without control, reducing the effectiveness of the monetary policy and the functionality of the banking sector in an uncontrolled manner.
• Provide solutions based on CBDC and blockchain developments so that the private sector can manage retail payments more effectively.
• Avoid systemic risks arising from the transition to a future financial system model that is not yet clear on the horizon.