FinS đ˛ for the Soul (14 Aug 2021): Myths and Truths about Central Bank Digital Currencies
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Latest headlines:
The rise of Central Bank Digital Currencies (CBDC)
Background: The Bank of Jamaica minted 230M Jamaican digital dollars ($1.5M), its first batch of CBDC this week. Bank of Ghana announced it has enlisted German outfit Giesecke+Devrient (G+D) for an upcoming central bank digital currency pilot. Samsung will join a pilot of the Bank of Koreaâs CBDC. Central banks around the world are falling head over heels for digital currencies. A BIS survey showed that 86% are actively researching its potential, 60% are experimenting with the technology, and 14% are deploying pilot projects. The disruption of a banking model familiar for over 800 years would have major repercussions described below.
What is a CBDC? How is it different from a private cryptocurrency or cash? Cryptocurrency is tokenised digital money that does not represent a claim on an issuing entity. Its tender status relies on adoption dynamics and it is fully decentralised and away from governmental scrutiny. On the other hand, a CBDC is digital public money issued by a Central Bank that has legal tender status. It is not equipped to safeguard privacy and would complement citizensâ claims on private money (available through bank transfers, cheques, credit and debit cards, and ATMs) via the banking system.
Tackling obstacles to broaden financial inclusion. Much has been said about a CBDCâs ability to boost financial inclusion by helping people without bank accounts get government aid such as coronavirus pandemic relief. However, it may be surprising to note that many of the 1.7B (31% of the worldâs population) are unbanked by choice. Two-thirds say they do not have enough cash to maintain a minimum balance. 30% feel they do not need an account. 26% of unbanked customers cite high bank fees as a deterrent. The bottleneck may not lie in the technology per se, but rather in structural economic, social, or operational issues. The 14% of Indiaâs population that remains unbanked are most likely to also be part of the 58% that do not have smartphones - and wonât be able to access electronic payments, whether sitting on the blockchain or not.
Increasing the speed and transparency of transactions. Local payment transaction speeds are almost instantaneous. Over 55 countries have an activated real-time payment system. The European Payments Initiative (EPI) is paving the way for a pan-European retail payments system leveraging the SEPA Instant Credit Transfer (SCT Inst) for instantaneous cross-border payments. Others like Singapore and Thailand have linked their systems to enable cross-border remittance in under 5 minutes. Beyond eliminating settlement delays for cross-border payments, CBDCs can provide more transparent FX rates and updates on payment status. It can also reduce the number of counterparties involved and increase interoperability between domestic systems. Correspondent banking transaction chains at present range from two to five or more intermediary banks.
Threatening the stability of the financial system. Issuance of CBDCs by foreign central banks could lead to the adoption of established international currencies at the expense of others. Widespread currency substitution would lead to large capital outflows and interfere with the countryâs central bankâs ability to control its monetary policy. Rapid substitutions can lead to bank runs and weaken financial institutions. In view of this, few central banks are considering the development of a fully anonymous system. Current designs restrict foreign residentsâ use of the CBDC and allow only residents and non-residents physically residing in a jurisdiction to access it. Building a multilateral system would require parameters limiting arbitrage.
Disintermediating the commercial bank. When individuals and corporates fully settle directly in central bank money rather than bank deposits, the commercial banksâ role as deposit takers would be eroded. They would cease to be as a major financing source intermediating between borrowers and savers and put in question the existing monetary order. An outsized role of central banks in credit allocation would likely be one that they are ill-equipped to handle. Ring-fencing the type of transactions that central banks have with commercial banks from that which commercial banks have with end-users in a multi-tier CBDC model would need to be explored further.
Infringing on personal privacy. In an account-based CBDC model, the nature of payments is transformed from a simple anonymised exchange of value to an exchange of value for a bundle of payment data linked to a customer profile. This may lead to financial discrimination by payment processors at the behest of authoritarian governments. It could alternatively be used as a method to weed out tax evasion as governments have greater oversight of monetary movements. Essentially, how much privacy a user can retain in a CBDC model would depend on design choices such as who is provided access to his or her information (an intermediary or the government), and how distanced is his or her personal information to the profile (either with a digital signature or masked pseudonym).
Examples of CBDC involvement: Bahamas issued the Sand Dollar in 2020, Cambodia launched its quasi-CBDC Bakong in Oct 2020, and the Eastern Caribbean issued DCash in Apr 2021. China has distributed 200M digital yuan (e-CNY) for trial in 4 cities. BoE and Treasury are exploring a potential UK CBDC and ECB is investigating the digital euroâs potential. Reserve Bank of India expressed a desire to create its own and the Central Bank of Venezuela is rolling out one in October.
Conclusion: There are a lot of boxes that need to be ticked to provide the right balance between oversight and confidentiality, interoperability and exclusivity, and the relative scope of public and private spheres of influence. Winning the publicâs support for CBDCs might be a publicistâs nightmare and would be considerably more difficult in countries with low levels of trust in their governments. In its wake would be payment providers, banks, and neobanks that awake one day having lost their raison d'etre in this not too distant future. Yet, with all its complexities lie the potential to provide deep technological integrations to transform a fragmented payment landscape ripe for change.
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