What’s the deal with Central Bank Digital Currency (CBDC)?

Finally, the global financial behemoth enters the digital arena.

The role of Central Bank

Central banks are controlled by national government banks and smaller commercial banks. Virtually every country in the world has a central bank. The nature of central banks and government bureaucracy varies by location, but they all set and react to similar core monetary policies and results So, while writing this article, I assume the reader has at least a very basic understanding of the powerful role central banks play in today’s world.

The pressures of government influence

Governments throughout the United States and the world have collected tens of billions of dollars of debts and unfinanced liabilities. It is not paranoid to think politicians will try to exhaust their debt. Meanwhile, central banks around the world are looking to stay above political issues.

Political criticism has shaped the public’s opinion to believe central banks didn’t design neutral monetary policies, even though most of the alleged failures from direct political pressures influencing their decisions. The greatest trio of offenders known as the Big Three Contemporary Central Banks are the Federal Reserve, the European Central Bank (ECB) and the Bank of Japan (BOJ).

Modern analysts have called for the reform of central banking, where independence is of paramount importance to any effective policy of the central bank.

Opinions on Central Bank independence

Sixteen years ago Ben Bernanke, as a US Federal Reserve governor, brought to the table central bank independence. During a trip to Japan, he stated on record “in the face of inflation… the virtue of an independent central bank is its ability to say ‘no’ to the government”.

The Bank of England achieved operational independence in 1997. The European Central Bank, which oversees interest rates for all countries sharing the common currency of the euro, was independent from its inception in 1998. Though recently, there’s been a strong political push for the opposite.

In 2013, the Bank of Japan agreed to coordinate its policy with the government, a move some of which called an alarming attack on central bank independence. Shortly after, the International Monetary Fund (IMF) held a conference entitled “Rethinking Macro Policy.” The consensus found that central banks should keep the full independence of its traditional monetary policy. Critics say independent central banks are too secretive and put commercial banks’ interests before taxpayers’, so the central banks say it’s time for more transparency and for people to have more control over their money than ever before.

Meet Facebook’s global stablecoin, Libra

Global “stablecoins” have gained momentum among major institutions after Facebook announced plans last year to launch a cryptocurrency named libra to carry a stable value connected to a currency basket and government debt.

There are many legitimate uses of stablecoins, and the hyper engaged community of cryptocurrencies ready to make this more effective and impactful. For countries where people suffer the consequences of corrupt public financial systems, stablecoins can hedge against hyperinflation.

Since the utility of any exchange medium increases with the size of the network it uses, the power of the stablecoin payment system depends on how quick it’s adopted.

As a “private option” to federal money, Libra challenges the competitive advantage of central banks over global monetary policy. This has led the Libra project to face intense regulatory pressure from Federal Reserve central bankers.

So, what are central banks and governments so afraid of?

As you might have expected, Libra has sped up the digital yuan’s development and boosted overall interest in Central Bank Digital Currency (CBDC) worldwide:

• In his testimony on 23 October 2019 to the House Financial Services Committee, Mark Zuckerberg highlighted the threat posed by China’s incoming digital currency as a reason for U.S. regulators to respond more favorably to Facebook’s cryptocurrency.
• European Central Bank Chairman Jerome Powell Member of Board Benoit Coeure warns of the potential risks of stablecoins, namely Libra, to global financial stability. While, more optimistic proponents argue that digital currencies of central banks would be a safer alternative to privately issued stablecoins, because they are a central bank’s direct responsibility.
• French Minister for Finance Bruno Le Maire sees Libra as harmful to sovereignty and suggests that the European Central Bank (ECB) should instead issue its own public digital money.
• Bank of England Governor Mark Carney also proposed to substitute the US dollar as the world’s reserve currency for a digital currency like Libra, but issued by central banks.
• In September, US Representatives of the French Hill (R AR) and Bill Foster (D IL) wrote an open letter to Jerome Powell, President of the Fed, urging the Federal Reserve to consider developing a US dollar digital currency.
• Former President of the U.S. Commodity Futures Trading Commission J. Christopher Giancarlo also requested the Fed to issue a digital U.S. dollar version to maintain its international payment popularity.

Central Bank Digital Currency (CBDC)

Central Bank Digital Currency (CBDC) is a new digital form of central bank money which can transfer between households and businesses with no need for commercial bank involvement.

Some of the largest central banks in the world will meet on an initiative to revisit the potential benefits and need for central bank digital currencies.

Jan 21 2020, the Bank of England officially announced it will consider the potential benefits of digital currency implementation. The following banks will meet to share past research, existing progress, and future proposals for the adoption of the digital currencies issued by central bank authorities.

• The Bank of Canada
• The Bank for International Settlements (BIS)
• The Bank of Japan
• The European Central Bank (ECB)
• The Sveriges Riksbank
• The Swiss National Bank

In an International Resolution Bank survey, out of 66 central banks, over 80 percent of central banks now report it involves them in some digital central bank (CBDC) work .

Potential First Movers

Several countries have already taken concrete steps or announced their plans for a future CBDC. The list below names each country with a head start on Libra and the current stage of developing their local CBDC.

• Thailand CBDC wholesale for interbank settlements in real time. Cross-border transfer testing is underway. No immediate retail plan or general purpose CBDC.
• Barbados Blockchain-based version of the Barbadian dollar released in 2016.
• Sweden E-krona project started in 2017 to study the need and feasibilities for a CBDC.
• Uruguay E-peso successfully piloted from Nov. 2017 to Apr. 2018.
• Bahamas Sand Dollar starting with a pilot phase in Exuma in December 2019 and extending in the first half of 2020.
• China Digital Currency Electronic Payment (DCEP) — Late 2020.
• France Bank of France to start pilot testing a CBDC — Q1 2020.
• Marshall Islands Marshallese Sovereign (SOV) — Release TBA.
• Saudi Arabia and United Arab Emirates Central banks of the two gulf nations will jointly issue a digital currency named “Aber” for interbank money transfer — Release TBA
• Turkey ‘to finish testing’ digital lira in 2020

The Likely Framework

Many CBDC forms with various effects on payment systems, monetary policy transfer and the structure and stability of the financial system are possible.

In a March 2018 report published by Banque for International Settlements and entitled “Central Bank of Digital Currencies,” a wholesale CBDC and a general purpose CBDC, they have two principal variations of the CBDC defined. The wholesale variant restricts access to a pre-defined group of users, while the general purpose is broadly accessible.

General Purpose CBDC

While a general purpose of the CBDC may in certain situations be an alternative to cash, the central bank introducing a CBDC would have to comply with the requirements for anti-money laundering and anti-terrorism finance (AML/CFT) and satisfy other supervisory and tax systems public policy requirements.

An anonymous general purpose CBCD is unlikely, but a non-anonymous CBDC would permit digital records and traces, which may even improve AML/CFT rules application.

Wholesale CBDC

A large-scale variant available to institutional investors that would be like reserves of interest-bearing central banks and reverse repo facilities, but widely tradable, can act as a safe asset comparable to short-term government bills.

A hybrid with some general purposes might compete with guaranteed bank deposits with pricing and composition of bank financing implications.

Weighing CBCD risks vs benefits

Introducing a general purpose or a wholesale only CBDC may bring a range of potential benefits to payment, clarification and settlement systems. Central banks should compare this case for CBDCs with existing or improved payment, clearing and settlement solutions, and testing the impact on other areas of their responsibility, especially monetary policy and financial stability.

What are the benefits?

CBDC may reduce bank run risk. The central bank would replace certain retail depositors holding bank liabilities with an (partly or fully) pass-through policy. It would internalize externalities and stabilize the provision of bank funding as a major player.

In many countries, the CBDC would resolve an awkward contradiction: while the public sector issues the legal tender, the legal limit on cash consumption prevents households and companies from making larger payments with publicly issued money.

Other potential benefits of CBDC include:

• Technological efficiency: they can send money transfers and payments from peer-to-peer in real time, instead of relying on the business hours of intermediaries such as commercial banks and clearing houses.
• Financial inclusion: safe central bank money accounts would be a strong instrument for financial inclusion that enables a free or low-cost bank account for every legal resident or citizen.
• Printing Costs: Full dollarization of CBDC would drastically reduce the cost of creating new money. The following data shows 20 years of currency minting costs, in millions of dollars.

2018 — $800 | 2017 — $674 | 2016 — $660 | 2015 — $689 | 2014 — $707 |

2013 — $717 | 2012 — $721 | 2011 — $650 | 2010 — $598 | 2009 — $503 |

2008 — $500 | 2007 — $576 | 2006 — $489 | 2005 — $497 | 2004 — $514 |

2003 — $514 | 2002 — $430 | 2001 — $344 | 2000 — $456 | 1999 — $487

• Payment safety systems: A secure and standard interoperable central bank-led digital payment instrument that serves as domestic digital payments instruments boosts confidence in private money systems and increases confidence in the entire national payment system, while also boosting competitiveness in payment systems.
• Banking competition: the provision of free central bank accounts that offer full money deposit security can enhance competition between banks to attract bank deposits by offering paid-up sight deposits once again.
• Financial security: CBDC would limit the practice of fractional bank reserves and potentially reduce the need for deposit guarantees.

What are the Risks?

There are many political risks. A longer central bank balance sheet could call for special interest groups to submit demands (e.g., for cheap finance for particular industries).

A transitional policy would also increase the transparency of the distributive effects of the monetary system. This could reinforce the opposition to bank support. Or, on the contrary, it will lead to more support for bank subsidies when it relaxes household and business funding constraints.

Additional risks are subtler. Potential undermining of cash users may weaken the political support for cash. Some see this as an advantage rather than a risk as the abolition of cash would make it far less effective for the central bank to reduce its interest rates without triggering the withdrawal of cash and empower monetary policy. Others disagree that cash provides a welcome safeguard against extreme monetary policies.

Do the opportunities justify the risks?

This varies between countries. Some countries’ pivotal point at which society will adopt a foreign currency is distant and in others it is closer or more menacing. Some monetary authorities will welcome more foreigners with national currencies, while others will not accommodate any exchange rate effects.

Competition in the banking sector and limited financial inclusion are important, but less urgent, political issues in some parts of the world.

Finally, a private sector synthetic CBDC that invested in a reserve portfolio would have a very different influence on the demand for national currencies, regardless whether it’s included in the portfolio; therefore, the fiscal and currency impacts of the synthetic CBDC are different for each country

It also depends on one’s personal views whether the opportunities justify the risks. For those who favor a strong central bank and less regulation can refine the CBDC at the expense of an extended balance sheet of the government and for those that reject the idea that central banks should privilege banks.