The Case For A Central Bank Issued Cryptocurrency
By Arjun Govind on ALTCOIN MAGAZINE
When most people think about the relationship between government and cryptocurrencies, it’s more often than not from a regulatory standpoint. As millions were made and lost as Bitcoin rose and fell, most people viewed the government as a regulator — a policer of IPOs and fraud, ensuring investors were protected.
However, I see the government potentially donning another hat. Central Bank Cryptocurrencies, or CBCCs for short, represent in my eyes one of the most promising and exciting applications of cryptocurrencies.
What’s Wrong With Fiat?
Well, a couple of things.
Let’s start with the humble dollar bills in your wallet. What’s wrong with them? While they’re universally accepted, they are not electronic. This means you‘re forced to transact with them in person. What’s more, those notes may degrade over time.
Well, what about money in the bank? While it enjoys the benefit of being electronic, it’s ultimately on the bank’s balance sheet as a liability. That means that if the bank happens to go bust, there’s no real way of getting your money bank.
The central banks of the world do have electronic money that they lend off their balance sheet, known as reserve money, however, those loans are not available to individuals. This trilemma of sorts is summarized in the Venn diagram below.
So what is the solution to this trilemma? You guessed it: a Central Bank Cryptocurrency or CBCCs.
The Origins of Central Bank Cryptos: Fedcoin
One of the first mentions of central bank cryptocurrencies (CBCCs) is from the Bank of International Settlements (BIS). In a 2015 report entitled “Digital Currencies”, they proposed having central banks go beyond acting as mere regulators and at least consider issuing a cryptocurrency.
The most iconic proposal of a retail CBCC was the Fedcoin. As the name may suggest, the intent behind Fedcoin was to have the Federal Reserve issue a cryptocurrency that functionally paralleled Bitcoin. Obviously, with Bitcoin’s volatile gains and losses, it’d be adventurous at best to make it official government tender.
Enter Fedcoin. The hypothesis? Having the Fed as a backer and central point of control would offer the advantages of lower transaction costs and greater stability.
Retail or Wholesale?
Scholarship points to two potential paths for CBCCs: a “retail currency”, used by consumers for daily transactions, and “wholesale”, as a Ripple-esque settlement and remittance network exclusive to banks and other financial institutions.
But if Bitcoin and other cryptos already exist, why have a CBCC?
The answer: negative interest rates.
Currently under the cash system, having negative interest rates creates arbitrage opportunities, as keeping cash under the proverbial mattress earns a 0% nominal interest rate. However, as the BIS points out, a complete replacement of CBCCs in place of cash would mean that depositors cannot avoid negative interest rates (without forgoing all of their central bank holdings, of course). This would give central banks far greater flexibility to stimulate economies, specifically during recessions, when interest rates are close to zero as it is.
In terms of evaluating whether retail CBCCs should be implemented, a key risk is an impact it would have on the financial services industry. Evidently, the disintermediation of banks may hurt their balance sheet, potentially causing the sector to decline.
On the other hand, wholesale CBCCs are a payment system designed to clear payments between a central bank and other financial institutions, thus lacking the “universal accessibility” that retail CBCCs have. Wholesale networks tend to be permissioned blockchains, as only select participants like banks should be able to access the network. The most promising example of this is Project Jasper by the Bank of Canada, which offers “real-time gross settlement” systems. The advantages of this are typical of decentralized systems — reduced fraud and transaction costs. A key barrier to this adoption is liquidity risk — while settlement systems like this make settlements more efficient, they also are more demanding in terms of liquidity, a common barrier to the adoption of such systems.
Will it Happen? Examples from Venezuela
While retail and wholesale CBCCs offer myriad benefits on paper, whether they will actually be implemented relies on a number of other considerations. Today, there is one retail CBCC currently being implemented today — the somewhat infamous Venezuelan Petro.
Facing hyperinflation and a spiraling debt burden, the Venezuelan government decided to announce the creation of a cryptocurrency called the “Petro”, backed by the country’s oil and gold reserves. The Petro is now accepted legal tender in Venezuela and recently had their ICO. The intent is to offer an alternative currency to the rapidly depreciating fiat and benefiting from low transaction costs and the other benefits of crypto in the process. While this might be seen as an adoption of a retail CBCC, the international community views the Petro largely as a sham for a number of reasons. For starters, with over $140 bn in foreign debt, the value of Venezuela’s reserves are inadequate to cover the supposed market cap of the Petro.
Additionally, a technologically unsound whitepaper coupled with misleading information from the Venezuelan President Maduro makes it seem like little more than an attempt to circumvent American sanctions. In fact, organizations that evaluate cryptocurrencies call the Petro a scam.
Alas, it may still be some time until we see a proper implementation of retail CBCCs.
Nonetheless, CBCCs are a fascinating and as yet relatively unexplored dimension of the dynamic between cryptocurrency and the government. There is a tremendous opportunity on both the retail and wholesale side of CBCCs, each coming with their own upsides. It is true that Venezuela currently operates a form of retail CBCCs, however, a lack of transparency and dubious technical specifications do not make it an exemplar of the promise of the technology more broadly.
Adapted from my LinkedIn article from January 8, 2019
Bibliography
1. Al Jazeera, “What is Venezuela’s New Petro Cryptocurrency?” https://www.aljazeera.com/news/2018/02/venezuela-petro-cryptocurrency-180219065112440.html, Accessed on Dec 1 2018
2. Bank for International Settlements Committee on Payments and Market Infrastructures, “Digital Currencies”, November 2015
3. Bjerg, “Designing New Money — The Policy Trilemma of Central Bank Digital Currency”, Copenhagen Business School Working Paper, June 2017
4. Bloomberg, “Crypto Rating Sites Are Already Calling Venezuela’s Petro a Scam”, https://www.bloomberg.com/news/articles/2018-04-03/crypto-rating-sites-are-already-calling-venezuela-s-petro-a-scam Accessed Dec 1, 2018
5. Chapman et. al, “Project Jasper: Are Distributed Wholesale Payment Systems Feasible Yet?”, Bank of Canada, June 2017
6. Investopedia, “Impossible Trilemma” https://www.investopedia.com/terms/t/trilemma.asp Accessed Dec 1, 2018
7. JP Koning, “Fedcoin: A Central Bank-Issued Cryptocurrency”, R3 Report 2014
8. Time, Russia Secretly Helped Venezuela Launch a Cryptocurrency to Evade U.S. Sanctions, http://time.com/5206835/exclusive-russia-petro-venezuela-cryptocurrency/, Accessed Dec 1, 2018
