Central bank digital currencies (CBDCs) could be necessary to ensure innovation and competition in digital economies, the Bank of Canada said in a research paper published on Tuesday.
As the economy becomes more and more digital, several issues have emerged that could be addressed through CBDCs. These include problems linked to competition in sectors like payment options, a resulting lack of innovation and development or exploration of new technologies, and an increased risk of market power abuse by large financial bodies as cash becomes less relevant in society.
Introducing a CBDC could address these issues in a more effective way than regulations and policies would, according to the Bank of Canada.
“In general, a CBDC as a basic outside option for payments could discipline the market,” the paper said. “Further, as a competition tool, a CBDC might be simpler than developing new competition policies in the complex and changing environment of big tech, and simpler than attempting enforcement via lengthy and uncertain legal battles,” it continued.
CBDCs could also make the use and further development of technologies like smart contracts and programmable money easier as their framework could be made available for public use and therefore create common ground for innovation.
Finally, CBDCs could also protect and even boost welfare levels, according to the Bank of Canada. The potential emergence of new markets and applications could increase welfare, while the added protection of consumers against market power abuses would prevent welfare from declining, the report said.
The Bank of Canada has not yet decided whether to pursue the development of a CBDC, and is currently in the process of researching and assessing its options.
The US is at a similar point in the process of potentially creating a digital dollar. Earlier this year, Federal Reserve Chair Jerome Powell said the central bank was still exploring the potential of a CBDC and would publish a report this summer. Last week, the European Central Bank also said it was launching a two-year exploration into a possible digital euro.
Japan’s plans for a digital yen could start to come together next year and the design of a potential central bank digital currency will be clearer then, the head of the ruling party’s digital currency initiative, Hideki Murai, told Reuters in an interview published on Monday.
“By around the end of next year, we’ll have a clearer view of what Japan’s CBDC would look like,” he said, adding this would not necessarily lead to a clear-cut decision on whether to roll out a central bank digital currency (CBDC). The Bank of Japan launched its exploration into a CBDC earlier this year and is currently researching and assessing the concept.
Murai also said having a better picture of the digital yen’s design would provide insight into how it might impact the existing financial system and institutions in Japan, which is currently undergoing significant shifts.
Private businesses have taken on responsibilities that previously fell to commercial banks, such as online settlement means, which have put the two industry groups at odds with one another. A digital yen could reverse the shift and commercial banks could benefit from this, Murai said.
“CBDC has the potential to completely reshape changes occurring in Japan’s financial industry.” he commented.
The Bank of Japan has previously said a CBDC would not significantly impact private businesses.
Murai also said the Bank of Japan would have to ensure the digital yen is compatible with CBDCs from other countries, to ensure it stays competitive against the Chinese digital yuan.
Digital currencies established by central banks would stoke wider demand for crypto assets, according to an Economist Intelligence Unit study, which comes as central banks including the Federal Reserve have been stepping up work in this area.
59% of study respondents agreed that the launch of digital currencies by official monetary authorities would lift up use of other forms of digital currencies and assets that are not backed by governments. The EIU study, commissioned by crypto exchange platform Crypto.com, posed the question to 200 institutional investor and corporate treasury management officials between February and April.
A central bank digital currency, or CBDC, is a type of central bank liability – like the US dollar – issued in digital form.
Meanwhile, 78% of the institutional and corporate survey takers consider the issuance of CBDCs as necessary to establish a functioning market for new financial instruments, such as digital bonds, to supplement the role of cryptocurrencies.
“If people get used to central bank money that is digital-they have access to central bank money in a digital format-that obviously makes them more comfortable to use other digital currencies,” Henri Arslanian, the crypto leader at PwC, one of the world’s largest auditing and financial services firms, was quoted as saying in the EIU study.
Central banks are “late to the race” in digital adoption but they still carry influence in such matters, the study said.
In Sweden, the central bank in April was moving toward testing with banks a so-called e-krona. The Bahamas became the first country to launch a digital version of its fiat currency with the October 2020 launch of the digital Sand Dollar.
The EIU study found that 74% of respondents believe their countries are or will become cashless.
In some ways, central bankers are like the “bitcoin bros” who have sent cryptocurrencies soaring in 2021, although they might not like to think it.
While crypto fans have taken to Twitter to shout about their gains, there’s been a quieter – but no less important – surge in interest in digital currencies in the hushed offices of the world’s central banks.
The Bank of England is weighing up launching a “Britcoin”; China is racing ahead with trials of its digital yuan; and European Central Bankers are giving speech after speech on central bank digital currencies, or CBDCs. The Federal Reserve is taking things more slowly but has enlisted MIT researchers to explore the issue.
Huw van Steenis was formerly a top advisor to the governor of the Bank of England and is now senior advisor to the CEO of Swiss banking giant UBS.
A well-known figure in the City of London, he wrote the Bank of England’s 2019 future of finance report, which looked hard at the outlook for payments and the pros and cons of central bank digital currencies.
Van Steenis is clear-eyed about CBDCs, arguing that they sometimes seem like “a solution in search of a problem.” But he told Insider they are definitely about central banks keeping control of money.
A CBDC would be a digital version of banknotes and coins, letting people hold and make payments in central bank money. At the moment, the digital money people use every day is created by commercial banks and held in accounts or on pre-paid cards.
Central bankers are watching cryptocurrencies closely
Some analysts have argued that central banks have been spurred to action by the crypto boom, and fears that bitcoin could become a global payments system. Bank of America researchers posited in March that CBDCs could be “kryptonite for crypto.”
Van Steenis thinks differently. “Approximately 95% of the money in most Western markets is not actually central bank money, but it’s money held in the bank in deposits in electronic format,” he says. “The world is already one in which [central banks] play a pivotal role, but they don’t dominate.”
The real issue is ensuring the stability of the financial system, van Steenis says, and that means keeping an eye on cryptocurrencies.
Yet the crypto world is still tiny relative to the amount of money in bank deposits, he says. “So I don’t think they’re running scared on bitcoin. But what they want to know is, is there an innovation they need to adapt and borrow from.”
The key concerns are dwindling cash use and tech-firm dominance
A major worry for central bankers is that, as the use of cash dwindles, private payment systems are becoming increasingly crucial and could shake the global financial system if they fail.
“If you think about the pandemic, it’s probably fast-forwarded the shift away from cash to digital by about three to five years,” van Steenis says. “No central banker ever wants to feel they might lose control of their currency.”
A CBDC would ensure everyone has access to a risk-free payment system, proponents argue, and would make transactions safer and more efficient. Just like going directly to the airline for your plane tickets online is faster and easier than going to see a travel agent.
Many central banks around the world are also asking themselves whether they want huge US technology companies like Visa, Mastercard and PayPal to dominate their national payments systems, van Steenis says.
Another common argument is that Western central banks are racing to keep up with China’s advanced CBDC project, which they say could threaten the dollar’s dominance.
But van Steenis is skeptical. “I just don’t see the geopolitical angle is what’s driving it,” he says. “If you ask the Swedes what’s driving the e-krona, it’s much more about a reduction in cash and inclusion and their responsibility to provide to society, than it is because they’re trying to keep up with friends around the world.”
CBDCs could eat the banking sector’s lunch
Whatever’s pushing it forward, the creation of central bank digital currencies looks set to throw up a number of problems to accompany the benefits.
One concern for bankers is that the technology might eat the financial sector’s lunch. The technical term is “disintermediation” – the idea that giving people access to CBDCs could stop them from needing banks at all.
Van Steenis, who knows Wall Street and the City well, says CBDCs must be created with a two-tier system in which people continue to hold accounts at banks and payment firms.
Yet, he says there are other risks. “What happens when we think about money being moved from country A to country B? Do you then allow your monetary base to be sent to a foreign bank? In which case, how do you regulate them? Do you lose control of your monetary policy?”
Crypto community can innovate while central banks are cautious
These sorts of issues mean central banks and the governments that ultimately control them will be very cautious about building CBDCs, says van Steenis. Countries will need to debate their pros and cons in a process that might take years, he added.
Fed Chair Jerome Powell said in March that the central bank would “move with great care and transparency” and wouldn’t proceed without support from Congress.
That opens the door for others to innovate, van Steenis says, not least those in the crypto world who are developing stablecoins and attractive financial networks.
He says: “Actually, I think the crypto community does have a real window of opportunity to help define a future whilst the central banks are cautiously, but studiously, trying to progress what they do.”
The value of the cryptocurrency market has slid by 23% in just the last five days. It’s been pulled lower by a sell-off in bitcoin most recently catalyzed by comments made by Tesla CEO Elon Musk.
The market cap for global digital currencies came in at $1.97 trillion on Monday, down from a recent peak of $2.56 trillion on May 12, according to data from CoinMarketCap.com.
“The crypto world is in the danger zone … as no one has a handle over short-term momentum because of uncertainty on where Elon Musk stands on bitcoin,” Edward Moya, a senior market analyst at Oanda, wrote in a note to Insider on Monday.
Bitcoin on Monday fell below $43,000 to its lowest point since February while other crypto prices suffered as well. Ether, the token of the Ethereum blockchain, was down nearly 8%, Cardano-ADA sank 10%, and Binance Coin fell about 9%. Dogecoin gave up 7%.
Solana was the only one of the 20 largest cryptocurrencies by market cap to gain ground Monday, up about 0.2%, according to CoinGecko.
Bitcoin dropped Monday after Musk on Twitter suggested Tesla might – or had sold – its holdings in the cryptocurrency. It slightly rebounded after Musk clarified that the electric vehicle maker still held its bitcoin stake. Bitcoin’s recent selloff was sparked after Musk last week said Tesla would stop taking bitcoin as payment because of the “insane” amount of energy needed to create new coins and secure the network.
“It seems unlikely that a massive financial institution will make a big bet on crypto in this current market as environmental concerns come to the surface,” said Moya.
Musk later suggested that Dogecoin may be a payment option for Tesla as he’s working with Dogecoin developers to improve system transaction efficiency.
“Everyone has been watching BTC fall, crashing 35% from all-time highs, just within a month,” said Justin Chuh, senior trader manager Wave Financial, a regulated digital asset investment firm, in a note. “Remember gravity and volatility? They exist. Some of the new crypto market entrants are about to have their first taste of risk
He continued: “A pullback was bound to happen. But we have to accept that those voices chirping around on social media aren’t helping and can actually make moves. This is healthy, but I think we all wish this didn’t happen.”
Broad risk aversion that hit US stocks on Monday didn’t aid the cryptocurrency market, said Moya, and “retail traders on social media platforms TikTok and Twitter are losing confidence and are getting closer to hitting the panic button.”
Cryptocurrencies will continue to exist even if central banks start issuing their own digital currencies, because they serve different purposes and have different appeals, analysts at Morgan Stanley have said.
They said in a report on Monday government-backed digital currencies probably pose the biggest risk to stablecoins – that is, cryptocurrencies that reflect underlying assets, such as the one planned by Facebook.
But the analysts, including Morgan Stanley’s chief economist Chetan Ahya, said “Cryptocurrencies will still exist, as they continue to serve other use cases.
“For instance, some cryptocurrencies can function as a store of value… as some segments of the public do not place their full faith in fiat currencies.”
Some analysts have suggested CBDCs could cut the appeal of technologies such as bitcoin, with a Bank of America report saying they could be like “kryptonite” to crypto.
But Morgan Stanley’s report said the reasons for investing in cryptocurrencies appeared to have evolved, with buyers increasingly viewing digital coins like bitcoin as new institutional asset classes, rather than replacement payment systems.
“Investors’ interest in cryptocurrencies has risen alongside the unprecedented monetary and fiscal policy response to the pandemic,” the report said.
The public can currently only hold central-bank issued money in the form of physical coins and notes, and largely uses electronic representations of cash held at banks or on prepaid cards to make payments digitally or online.
Morgan Stanley’s major report into CBDCs showed they would probably be quite different from cryptocurrencies, as they would not use a decentralized security system, or blockchain.
The European Central Bank has made similar arguments to Morgan Stanley, saying CBDCs have little to do with cryptocurrencies, which it sees as speculative assets and not actual currencies.
Central banks will soon need to issue digital currencies as the use of cash slowly becomes irrelevant, according to UBS chief economist Paul Donovan.
“Central bank digital currencies are likely to start becoming part of individual economies’ payment systems in the coming years,” he said in a note published this week.
People are using physical forms of money, like notes and cash, much less than before. Moreover, about half of Sweden’s banks no longer accept cash and its economy is expected to go cashless by 2023.
“We wave debit cards and mobile devices around with the reckless abandon of a first year student at Hogwarts trying out a wand, magically paying for things without ever having to touch cash,” Donovan said, referring to the boarding school in the “Harry Potter” series of children’s books.
Donovan laid out specific differences between how CBDCs would operate compared with cryptocurrencies. CBDCs would be interchangeable with notes and coins in circulation, accepted for tax payments, and wouldn’t have wild fluctuations in value – unlike typical crypto, such as bitcoin. Officially backed digital currency supply could change depending on the central bank’s ability to regulate the spending power of the currency, he said. Meanwhile, cryptocurrencies are decentralized and cannot be controlled by any one party.
He also said digital cash is a direct claim on the private bank to which its account is tied, and not on the government. This means government-produced money is becoming less significant, while digital money produced by the private sector is increasing in importance.
“If central banks want to stay relevant as cash becomes less relevant, they might have to consider entering the world of digital money,” he said.
China is among the leading economies looking closely at CBDCs. The People’s Bank of China aims to become the world’s first to issue a digital currency as part of a push to reduce its reliance on the dollar-denominated financial system, according to Reuters.
Federal Reserve Chairman Jerome Powell said last month a potential digital dollar is a “high priority” project for the US. But he thinks CBDCs should exist alongside cash and other forms of money, rather than replace them entirely.
Federal Reserve Chairman Jerome Powell said on Thursday prospective digital currencies issued by central banks must accompany cash and other types of money within a flexible payment system.
“A recent report from the Bank for International Settlements and a group of seven central banks, which includes the Fed, assessed the feasibility of central bank digital currencies (CBDCs) in helping central banks deliver their public policy objectives,” Powell said in prepared remarks at a payments conference hosted in Basel, Switzerland.
“One of the three key principles highlighted in the report is that a CBDC needs to coexist with cash and other types of money in a flexible and innovative payment system.”
The COVID-19 crisis has underscored the less systematic areas of the current payment system and sped up the need for digitalization, he said. The Federal Reserve Bank of Boston is said to be collaborating with MIT researchers to explore digital currencies in addition to experiments the Fed’s board of governors is conducting.
Powell was addressing attendees at a conference aimed at discussing improvements in cross-border payments hosted by the Committee on Payments and Market Infrastructures.
“By definition, cross-border payments involve multiple jurisdictions,” he said. “So it will only be through countries working together, via all of the international forums-the Group of Seven, the G-20, the CPMI, the FSB, and others-that solutions will be possible.”
He said that achieving an improved payments system would be made possible through the combined engagement of policymakers, private-sector participants, and academia.
Powell recently said that a potential digital dollar is a “high priority” project for the US, although that comes with notable technical and policy-related issues. As the issuer of the world’s reserve currency, the US doesn’t have to be the first to create one, but it does have to get it right, he said.