Central banks are bracing for a showdown with purveyors of cryptocurrencies and other private forms of money. To help win that battle, they are counting on a still murky concept known as central bank digital currencies, or CBDCs.
In theory – and it is all theory at the moment – CBDCs could allow government-sponsored central banks to protect territory threatened by the rise of digital tokens and private payment platforms run by giant tech companies. If countries are to retain control over their monetary systems, CBDCs may prove vital.
But their success is far from guaranteed. Even explaining what CBDCs are can take a bit of work.
Think of them, for starters, as digital cash that you might be able to hold on your smartphone or on a payment card, but which would function in many ways just like a debit card does now.
The important difference lies under the surface. Unlike a debit card, a CBDC would be a direct liability of a central bank, not a call on some commercial intermediary. A CBDC’s digital nature, its status as legal tender, and its direct tie to the central bank could potentially speed money transfers and reduce transaction fees. It could also open the door to a whole new array of economic possibilities.
Imagine, for instance, a world where you and every other Canadian have a personal account directly with the Bank of Canada. You would still deal with a commercial bank such as Royal or TD for most of your everyday banking needs, but, unlike today, ordinary people would also have a direct link to Canada’s central bank.
In this world, if another pandemic were to hammer the economy, the central bank could deposit stimulus money directly in your account and the account of every other Canadian citizen. There would be no paperwork, no waiting for cheques. The money, in the form of digital loonies, would simply appear in your central bank account.
The central bank could go even further: To ensure better-off people don’t simply hoard the windfall, and to guarantee the economy gets the maximum short-term boost from the cash infusion, it could put a stale date on the digital loonies it has just given you. If the funds were not spent within, say, the next three months, the bounty could be programmed to vanish from your account.
To be clear, such scenarios are still a long way off. In fact, concepts such as a programmable CBDC may never materialize, depending on how central banks decide to proceed. But a report this week makes it clear that the fight to control the next generation of the world’s money has now officially begun.
The report, from the normally soft-spoken Bank for International Settlements (BIS), the international forum of central bankers, amounts to a declaration of hostilities against many emerging forms of private money.
Its targets range from digital tokens issued by privately designed algorithms (think bitcoin) to payment systems operated by big tech companies (think Alipay, the sprawling China-based online payment platform operated by Ant Group, an affiliate of Alibaba).
Crypto comes in for a particularly hard time. “By now, it is clear that cryptocurrencies are speculative assets rather than money, and in many cases are used to facilitate money laundering, ransomware attacks and other financial crimes,” the BIS warns. “Bitcoin in particular has few redeeming public interest attributes when also considering its wasteful energy footprint.”
The BIS doesn’t have many good things to say about stablecoins, either. These digital tokens, such as Tether, attempt to tie their value to underlying fiat currencies, typically by holding reserves of greenbacks and other securities. “Stablecoins attempt to import credibility by being backed by real currencies,” the BIS sniffs. It cautions these new tokens are only as good as the value of the underlying national currencies they are tied to.
The biggest threat of all to the existing monetary system may be the entry of big tech into financial services. The BIS notes that payment systems operated by tech companies benefit from a powerful network effect in which just about everyone flocks to one or two major platforms. In China, for instance, nearly all mobile payments are now processed by either Alipay or its rival WeChat Pay.
Left unchecked, this centralizing tendency would eventually hand unprecedented power to a handful of global tech giants. These online empires would possess tremendous clout in setting fees. They would also have access to a disturbing amount of highly sensitive information on who is paying whom for what.
“The walled garden ecosystems of big techs” could result in “a vicious circle of entrenched market power and data concentration,” the BIS warns.
So what to do? Central banks must embrace technology to find ways to safeguard public trust in government-backed money, the BIS argues. One way to do that is by developing CBDCs that can deliver many of the benefits promised by crypto or private payment systems, while ensuring that central banks remain firmly in control of their monetary systems.
Done right, a CBDC could help prevent fragmentation of a country’s payment systems. It could also respect data privacy rights. And it could provide new ways for people who have traditionally relied on cash to participate in the financial system. These unbanked people – typically unemployed, older workers – otherwise run the risk of being left behind in economies that increasingly rely on credit cards and smartphones.
The problem lies in the details. More than 80 per cent of the world’s central banks (including the Bank of Canada) are studying CBDC, and China is running trials of a digital yuan, but any large-scale implementation still seems a distance off, says Mark Williams, chief Asia economist at Capital Economics, who has been closely following the digital yuan experiment.
CBDC visionaries like to mull scenarios in which every citizen has an account with a central bank, the central bank pays interest on those accounts, and policy makers use programmable money in ingenious ways. But none of that seems to be part of any central bank’s current plan. “It’s striking just how low policy makers are aiming,” Mr. Williams told a webinar this week.
That may reflect the challenge of figuring out just how a CBDC should co-exist with commercial banks. Given a choice between holding their money in a central bank and trusting it to the dicier fortunes of a commercial bank, many people in many countries would choose the former.
Especially in a financial crisis, people might flock to get their money out of commercial banks and into an ultra-safe CBDC. This rush to withdraw deposits could hammer commercial banks and help spread the crisis, not reduce it.
Don’t count on such problems being resolved any time soon. CBDCs are today’s hot topic in central banking circles. They are likely to remain that way for years to come.
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