Why central banks are getting into the crypto game

From bit­coin to ethereum, dig­i­tal cur­ren­cies have been her­ald­ed as a new dawn for mon­ey. They allow for faster, cheap­er trans­fers, pro­mote finan­cial inclu­sion and offer greater pri­va­cy, accord­ing to their pro­po­nents.  

How­ev­er, the promise of anonymi­ty has also made them a favoured finan­cial medi­um for fraud­sters and crim­i­nals. And beset by explo­sive volatil­i­ty, they fall far short of being a viable pay­ment method. But what if that wasn’t the case?

For mon­e­tary author­i­ties world­wide, this is the tril­lion-dol­lar ques­tion. Spurred by the cryp­to sector’s mete­oric rise, dozens are look­ing at launch­ing their own cen­tral bank dig­i­tal cur­ren­cies (CBD­Cs) — vir­tu­al mon­ey that replaces cash with elec­tron­ic tokens. 

Done cor­rect­ly, this could democ­ra­tise finance, clamp down on crim­i­nal­i­ty and offer far greater effi­cien­cy. Yet deep in CBD­Cs’ dig­i­tal DNA are con­cerns around state sur­veil­lance and indi­vid­ual pri­va­cy and the prospect of a cash­less soci­ety that might not work for all.

Playing catchup

For years, cen­tral banks had lit­tle more than pass­ing inter­est in vir­tu­al mon­ey. When Face­book announced Libra, a pro­pri­etary dig­i­tal cur­ren­cy that would mon­e­tise its sprawl­ing social net­work, that abrupt­ly changed. 

“After Face­book made its announce­ment in mid-2019, cen­tral banks became con­cerned about mon­e­tary sov­er­eign­ty,” explains Ole Moehr, asso­ciate direc­tor of the GeoE­co­nom­ics Cen­ter at the Atlantic Coun­cil, an inter­na­tion­al think tank. “They were, and still are, wor­ried that they might lose that sov­er­eign­ty if a dig­i­tal cur­ren­cy like Diem [Libra’s new name] could effec­tive­ly lever­age the platform’s 2.8 bil­lion users.”

Two years on, cen­tral banks are scram­bling to catch up. The Atlantic Council’s GeoE­co­nom­ics Cen­ter, which tracks CBDC devel­op­ment glob­al­ly, found that 35 mon­e­tary author­i­ties were research­ing vir­tu­al cur­ren­cies in mid-2020, Moehr says. Today that num­ber has more than dou­bled. 

Chi­na, Cam­bo­dia, and the Bahamas are lead­ing the pack. Each has a pilot CBDC in cir­cu­la­tion and there is spec­u­la­tion of a nation­al roll­out in Chi­na next year. 

Eager to make up ground, though fun­da­men­tal­ly more cau­tious, West­ern economies are mov­ing ahead with their own CBDC plans. In April, the Bank of Eng­land and the UK Trea­sury launched a task­force to exam­ine the poten­tial of a dig­i­tal pound, snap­pi­ly dubbed “Brit­coin” by Chan­cel­lor Rishi Sunak.  

Yet as Facebook’s Diem shows, there remain some fair­ly hefty reg­u­la­to­ry road­blocks. Sta­ble­coins — cryp­tocur­ren­cies that peg their mar­ket val­ue to an out­side asset, such as the US dol­lar or gold — car­ry sys­temic risks, G7 cen­tral bankers and finance min­istries have decid­ed, reit­er­at­ing at a meet­ing in ear­ly June that tighter reg­u­la­tions be applied before launch per­mis­sion is grant­ed. 

The same goes for their own CBD­Cs; dig­i­tal cur­ren­cies must oper­ate “with­in appro­pri­ate pri­va­cy frame­works and min­imise spillovers”, G7 finance min­is­ters con­clud­ed this month.  

CBDCs vs cryptocurrencies

This com­mit­ment to reg­u­la­tion is the sin­gle biggest dif­fer­ence between CBD­Cs and cryp­tocur­ren­cies such as bit­coin or ethereum.   

They’re like­ly to share some of the same foun­da­tion­al tech­nol­o­gy, name­ly using blockchain, an elec­tron­ic ledger that allows trans­ac­tions to be record­ed and accessed in real time. How­ev­er, cryp­tocur­ren­cies are decen­tralised and unreg­u­lat­ed, gov­erned not by a sin­gle enti­ty but a dis­parate band of online cus­to­di­ans. By def­i­n­i­tion, CBD­Cs are con­trolled by a cen­tral body. 

The arrival of CBD­Cs could there­fore pre­cip­i­tate the demise of their unreg­u­lat­ed fore­bears, some experts believe. 

“In terms of the use case for bit­coin and ethereum as cur­ren­cies, CBD­Cs cer­tain­ly do throw that up into the air,” says Susan­nah Streeter, senior invest­ment and mar­kets ana­lyst at Har­g­reaves Lans­down. 

“If there’s an alter­na­tive sys­tem of dig­i­tal cur­ren­cy that is sup­port­ed and reg­u­lat­ed by cen­tral banks, peo­ple will migrate over to that sys­tem, not least because their mon­ey will be guar­an­teed.”

Ten pounds, dol­lars, or euros of CBDC would, in oth­er words, always be worth ten pounds, dol­lars, or euros, backed by the full faith and cred­it of the gov­ern­ment. Cryp­tocur­ren­cies, on the oth­er hand, are prone to vio­lent swings in val­ue, ham­per­ing their abil­i­ty to serve as a seri­ous pay­ment medi­um. 

Then again, this spec­u­la­tive nature is pre­cise­ly what appeals to so many cryp­to enthu­si­asts. Rather than treat­ing their hold­ings as a viable cur­ren­cy, most view them as assets, hop­ing for stratos­pher­ic returns, or as hedges against infla­tion, tak­ing the place of gold. That’s unlike­ly to change, even with cen­tral banks in the game.  

Per­haps the more per­ti­nent ques­tion is whether CBD­Cs will squash the growth of glob­al sta­ble­coins, such as Diem. While they could well co-exist in a shared reg­u­lat­ed ecosys­tem, cer­tain rival­ries are like­ly to emerge if non-state vir­tu­al cur­ren­cies offer their cus­tomers inter­est, throw­ing the gaunt­let down to CBD­Cs, which aren’t expect­ed to car­ry finan­cial incen­tives.

Goodbye to the commercial bank — and cash?

A sta­ble­coin ver­sus CBDC show­down would not be a bad thing for con­sumers — com­pe­ti­tion dri­ves down costs, after all. But there’s one group who will be watch­ing the devel­op­ment of dig­i­tal mon­ey with trep­i­da­tion: com­mer­cial banks.   

As CBD­Cs are a com­plete replace­ment for phys­i­cal mon­ey, not sim­ply a rep­re­sen­ta­tion of it as is the case with today’s elec­tron­ic cash, the inter­me­di­ary role of high street or online banks would, in the­o­ry, be very lim­it­ed. With mon­ey held direct­ly by the cus­tomer (on their phone or oth­er dig­i­tal device) why involve a poten­tial­ly cost­ly mid­dle­man? 

The answer, says Antho­ny Cul­li­gan, founder and chief engi­neer at blockchain com­pa­ny SETL, is exper­tise. 

“There’s still going to have to be some­body who curates us into this dig­i­tal mon­ey world,” he says. “The Bank of Eng­land is a small place, it’s not going to be run­ning a ser­vice for 50 mil­lion cus­tomers. It couldn’t do it, because it’s not a tech­nol­o­gy organ­i­sa­tion in the same way com­mer­cial banks are.”

The cash econ­o­my is like­ly to be less resilient. The dis­ap­pear­ance of phys­i­cal mon­ey is already well advanced — only 23% of trans­ac­tions in the UK relied on cash in 2019, accord­ing to trade body UK Finance, down from close to 60% a decade ear­li­er. Con­tact­less pay­ments have pro­lif­er­at­ed dur­ing the pan­dem­ic, a trend that CBD­Cs, being whol­ly vir­tu­al, will almost cer­tain­ly accel­er­ate. This could dis­en­fran­chise poor, rur­al and elder­ly com­mu­ni­ties that large­ly rely on cash, par­tic­u­lar­ly if dig­i­tal cur­ren­cies are acces­si­ble offline. 

It’s pos­si­ble, how­ev­er, to make quite the oppo­site argu­ment: that CBD­Cs will advance the cause of finan­cial inclu­sion. For peo­ple estranged from the bank­ing sys­tem, there’ll be no need for an account or cred­it card to access their mon­ey, just an elec­tron­ic device.   

Privacy concerns

A shift away from cash could also help author­i­ties crack down on fraud, because with less phys­i­cal mon­ey in cir­cu­la­tion, it’ll be hard­er to laun­der large sums. Sim­i­lar­ly, banks will have an eas­i­er time keep­ing track of cur­ren­cy move­ment, with the own­er­ship of every elec­tron­ic token dig­i­tal­ly doc­u­ment­ed, help­ful when tack­ling the likes of tax avoid­ance. 

This sort of sur­veil­lance capa­bil­i­ty is, on the flip­side, fraught with civ­il lib­er­ty con­cerns, ana­lysts argue. 

“Pri­va­cy is a major con­cern, and is relat­ed to trust in both gov­ern­ments and big tech­nol­o­gy com­pa­nies,” says Sab­ri­na Rochemont, chair of the Insti­tute and Fac­ul­ty of Actu­ar­ies (IFoA)  Cash­less Soci­ety Work­ing Par­ty.

“If accounts are held with a pay­ment ser­vice provider and the use of a CBDC is free of charge, con­sumer and trans­ac­tion data may become the rev­enue stream for pay­ment busi­ness­es. Most of us leave vast trails of data in our dai­ly lives as we seek con­ve­nience. Who do you trust more with your data: a cen­tral bank or pri­vate busi­ness­es?”