The irresistible rise and rise of central bank digital currencies

As in other spheres of activity, Covid-19 has accelerated a trend, in this case towards the replacement of cash that was already in place. Fears that cash might literally be dirty and infected have helped drive digitisation of money to hitherto undreamt - of levels, as debit cards, credit cards and other forms of digital payment have gained a firm foothold at much lower levels of transaction value than were previously accepted as a minimum for non-cash.

To use, or perhaps even misuse, a popular metaphor, the CBDC (Central Bank Digital Currency) train has left the station and is gathering pace. Anyone who fails to board will be left well and truly behind in one of the potentially most significant geopolitical and macroeconomic advances of our age.

The question of certainty

There are a number of reasons – ranging from political and philosophical considerations to the economic and technical – why this is unfolding. Very little is certain at this stage, but we believe that we can state that whatever the eventual timing of the delivery of CBDCs might be, it will be dependent upon the successful development of suitable infrastructure at the national and international level, and that this is expected to be built on a highly sophisticated public sector/private sector collaborative model requiring the highest level of technological expertise and understanding. Depending on the form CDBC will take (eg: retail value reserve only? international currency ambitions? …), heavy investments might be required, and it could take at least three to five years.

The history of cryptocurrency to date has been rooted purely in private sector initiatives. The origins of the most prominent, and best known, Bitcoin, remain shrouded in uncertainty, if not downright mystery. We still do not know the true identity of its supposed creator (Satoshi Nakamoto), despite the varying claims that have been made in recent years. One cannot help but be reminded of the famous scenes in a certain pseudo-historical moving picture, in which a number of men stand up in turn and claim to be the rebel leader, Spartacus. Or even Monty Python’s Life of Brian.

The growing number of investigations and experiments launched by the likes of the US Federal Reserve, the European Central Bank, the Bank of England, the Bank of Japan, the Swiss National Bank and the People’s Bank of China means this will change. All are, of course, important to their various supporters, but as committed Europeans, we believe it is vital for the ECB’s efforts to be at least as successful as the others. 

Sovereignty still matters

If nothing else, it is a question of sovereignty, centred on the monetary policy control of a currency within one’s borders and the share of a currency in international transactions. We think these considerations on their own will drive the development of the digital euro and the digital dollar. 

Facebook’s proposals for its Libra ‘stable coin’ came as a shock to central bankers, who immediately saw a threat to their currency sovereignty. The prospect of Mark Zuckerberg displacing central banks and staking a leading claim in the digital currency universe with Libra or a future successor to Libra is almost literally unthinkable. Even the ‘stable coin’ mooted by the globally respected JP Morgan could prove too hard for central banks to swallow.

The harsh reality is, however, that Facebook has a well established and apparently highly loyal international user community that is almost 10 times the size of the population of the United States of America. That alone gives some cause for concern.

Some thorns will persist

Not everything in the garden will be rosy. Some thorns will persist. While CDBC could help international payments to be faster and cheaper, but payment systems in developed countries broadly meet customer needs already, and we should not believe that CBDCs will represent a panacea, or universal cure.

They will not solve existing foreign exchange limitations (including, for example, currency controls and the operating hours of central bank settlement systems) and filtering issues due to worldwide non-harmonized AML processes in payments that can create friction when managing international payments flows. Moreover, as Sweden has found, the disappearance of cash can lead to even higher levels of financial and social exclusion than are currently prevalent in a number of countries.

In conclusion

Despite the bullish sentiments being expressed by many cryptocurrency fans, the overarching impression is that no single CDBC would be adopted worldwide tomorrow and that we would end up with the same fragmentation as today, with local CDBC being only additional currencies to manage, a widely available alternative to existing currencies and their underlying systems rather than a complete replacement.
 
It is important to test and understand CDBC mechanisms so that we do not miss an exceptional opportunity to develop a public/private co-operation that could be beneficial to the entire economic ecosystem. But the essential fundamental question remains: how far should we go with currency digitalization? Perhaps the answer will be clearer by Sibos 2021…