What are they?
Central Bank Digital Currencies (CBDCs) have been in and out of the news over the past few years but there’s still some confusion as to what they are, what they’re for, and what they will ultimately mean for regular people. Also referred to as Digital Base Money (DBM), or Digital Fiat Currency (DFC), they are digital versions of the national currencies issued by central banks. Their development and implementation have been discussed since Bitcoin rose to prominence in the wake of the 2008 financial crisis. This is the big thing that separates these two types of digital currency; even though CBDCs may make use of distributed ledger technology (DLT, blockchain), they are issued and controlled by central banks, and as such are an extension of central bank policy.
Who’s working on them?
Over the past few years, a number of central banks from around the world have made various announcements indicating that they are exploring the possibilities of issuing their own digital currencies. These include the Bank of England, the central bank of Sweden, the Bank of Japan, the Central Bank of Uruguay, the People’s Bank of China, the Eastern Caribbean Central Bank, and recently even the US Federal Reserve, among others. Though many CBDC projects have often remained at the discussion stage, China, the Marshall Islands, Sweden, the Bahamas and the Eastern Caribbean Currency Union, and the bank of Thailand currently have test projects in operation. The European Central Bank has thus far denied the possibility that it will issue a digital version of the euro but is actively researching the subject.
Why are central banks interested?
Though cryptocurrencies are not often talked about in official mentions of CBDCs, it’s clear that they have been a major influence and have definitely hastened the discussion around digital forms of money in general. Cash has always been a sizeable portion of the money supply that central banks have little direct control over or ability to track. The way central banks have traditionally managed the cash they have in circulation (remember that cash is a central bank liability) is by influencing what people do with their cash by setting interest rates and removing or adding new units into circulation. The emergence of decentralised digital currencies that function like cash but come with all the added features of security, self-sovereignty and transparency (ability to track transactions), has spurred central banks to innovate their own digital cash solutions.
This is a very interesting question. Who benefits rests almost entirely on which form of money becomes most widely used by the general public in the future. So far, we have discussed cryptocurrencies and CBDCs; however, there has also been talk of corporate digital currencies like Facebook’s Libra project, which aims to be a centralised digital currency to be used across Facebook’s ecosystem of apps and advertising partners. The global reach of social media platforms like Facebook, when combined with the frictionless nature of digital currencies, impinges on some of the powers that have thus far been exclusively associated with central banks (the ability to issue units of currency that are considered legal tender.)
If you take these three radically different types of digital currency into consideration, you can see that each is pulling in a slightly different direction. Cryptocurrencies like bitcoin and ether are not controlled by any issuer, are self-sovereign by virtue of their decentralised nature and the fact that anyone can participate in their respective networks in a permissionless manner. Corporate coins like Libra are centralised and permissioned but seek to capitalise on the massive network effect of large tech platforms to create more efficient ways of digitally moving value around between participants on their networks. Central banks, which are the current incumbents as far as money creation goes, see the threats posed to their ability to control how people use money (and indeed what money they choose to use) as the technology continues to evolve so rapidly. This is why they are searching for ways to extend their reach into the digital realm.
Some examples of possible CBDC uses
Many in the crypto space have given little credence to the viability of CBDCs due to their centralised nature because, typically for a cryptocurrency to be worth anything, it has to be decentralised (not controlled by any one party). This is because a digital currency that is controlled (either by a central bank or a corporation) can be censored. Transactions can be blocked and parties prevented from having access to financial services simply by blacklisting accounts. This is something that cannot be done in the world of crypto.
However, if we look at CBDCs from the perspective of central banks, we can see how useful they would be for the implementation of a variety of monetary policies. Imagine a central bank that wanted to run negative interest rates and actively discourage participants from leaving their money lying dormant in their digital accounts. Today, even though we have negative interest rates in much of the world, most banks still do not charge their customers for money held in deposit. Negative interest rates could be easily implemented with CBDCs in a relatively frictionless way from the perspective of the central bank. Money that remained in a digital account (rather than being used in the economy) could easily be charged a negative interest rate.
Additionally, various implementations of Modern Monetary Theory (MMT) including Universal Basic Income (UBI) are far easier to carry out with digital currencies than they would be with today’s outdated and inefficient government bureaucracies. In the case of UBI, a monthly, non-means-tested payment of a given sum to every citizen could easily and cheaply be made directly from the central bank in question into every account that conforms to certain criteria (e.g. citizens up to date on their tax returns etc.) With the continuing toll that the corona crisis is taking on the global economy, many analysts are now expecting central banks to resort to some form of MMT, and CBDCs would allow for such a move to be made much more efficiently.
Not to mention the incredible amounts of data that any central bank that implements its own digital currency would have access to. At the moment, the movement of cash is more or less opaque to central banks. Were this cash to become as transparent, central banks could track the flow of every single unit of currency they currently have in circulation.
The cat is very much out of the bag as far as digital currencies are concerned. Had it not been for the Great Financial Crisis and the invention of Bitcoin, perhaps central banks may have maintained their monopoly over money creation for another generation or two. But now, with functional alternatives that have proven incredibly resilient to all manner of attack, it is looking increasingly likely that the next decade or so will see the gradual introduction of various forms of national digital currencies. This will take place alongside the evolution of the cryptocurrency space, the emergence of corporate forms of digital money and an ever more complex regulatory environment.
The interesting tug of war outlined above between central banks, corporations and decentralised cryptocurrencies will hopefully keep certain forms of overreach in check as governments who are heavy-handed in their use of all the additional control that centralised digital currencies give them, could see people fleeing to decentralised cryptocurrencies in an effort to maintain control of their money.
by Giles Coghlan, Chief Currency Analyst, HYCM