CBDCs (Central Banks’ Defence against Cryptocurrencies)‍

Central banks have been looking at cryptocurrencies for some time not without trepidation. Bank of England and Swedish Riksbank among others have contributed papers and declared their intent to participate in the emerging crypto universe.

After years of talking it down, trashing and dismissing it, governments (and central banks) continue to be mystified by the resilience of the Bitcoin system – indeed it has been going from strength to strength (admittedly though the value of a bitcoin has been pushed up by a massive tailwind of speculative demand). Created out of thin air and maintained by a lot of (some say, unnecessary) computing power, it has nevertheless validated free-market economic theory that ultimately the value we place on something is driven by the two fundamental levers of economics: supply and demand. True, it is not a currency but a digital asset but in the long run it may well come to represent a global currency of sorts or at-least a store of ready value. Governments have finally realised that they may not be able to stop cryptocurrencies despite restricting or banning them outright.

Central banks have been thinking hard what to do in this space. Just recently, the governor of Norges Bank, the central bank of Norway, Øystein Olsen commented in the context of CBDCs or Central Bank Digital Currencies – digital currencies issued and managed by central banks - that “central bank cash provides the payment system with a number of important attributes that may be relevant to retain and develop further by issuing a CBDC.” Olsen’s statement does not refute the primary objective for all central banks in the area of cryptocurrencies. It is the need to stay relevant and in the centre and in control of money flows when faced with the resilient rise of crypto especially Bitcoin – an innovation that is designed to bypass central banks.

Governor Olsen acknowledged that ,”additional knowledge is necessary for us to be able to decide whether issuing a CBDC is appropriate," again revealing what is already known that central banks do not have yet have an idea how CBDC’s will work and what broad benefits they will confer over and above what existing technologies and operations offer.

‍Anarchy or Hierarchy

‍Eric Schmidt, ex CEO of Google, once called the internet “the largest experiment in anarchy that we ever had.” In that sense, Bitcoin is the largest experiment in anarchy in banking and payments that we ever had. The Bitcoin system was masterfully laid out in a paper published about a decade ago and the fact that it has survived attacks by critics and by hackers for some time says something about its resilience. CBDCs, on the other hand, are in the very first stage of conceptualisation and, as things stand, their current sphere of usefulness and relevance is rather limited.

What distinguishes Bitcoin from CBDCs is that it is decentralised which means there is no one – no single entity or group – that decides when to issue new bitcoins. It is managed by an autonomous system maintained over a chain of hundreds of thousands of linked computers across the world. It bypasses central banks, who issue money, and governments who raise money through taxes – monopolistic privileges that neither is in a hurry to forgo.

Not surprisingly, central banks and governments are dismissive of Bitcoin and other cryptocurrencies. Central Bank Digital Currencies (CBDC) will be crypto tokens – just like bitcoins – except that they will be centrally issued and managed by a central bank. And here’s the rub. Users must have an account with that central bank or an agent of the central bank to be able to transfer or receive CBDCs. This is because electronic tokens can be copied and used again and again – something which cannot happen if a token represents value and is used to exchange it. In the Bitcoin system, the mechanism of the blockchain ensures such digital counterfeiting or “double spend” does not take place. In the case of CBDCs, central banks will have to ensure against fraud from double-spend by crediting and debiting user accounts.Oddly, that is that is what central banks do already. It is called clearing and settlement. The tasks of clearing and settlement are already becoming cheaper, faster, and better. CBDCs may further simplify and improve but they hardly constitutes a giant leap forward.

CBDCs do have one advantage over crypto. They will be as stable as the “real” or fiat currencies they represent. Bitcoin and other cryptocurrencies have been inherently volatile as their demand is driven by speculative forces. But with “stable coins” – privately issued crypto pegged to fiat currencies now emerging, this advantage too will be lost.

‍Back to Basics

‍With current central bank thinking, unless it progresses further, CBDCs represent a marginal innovation lacking a compelling case. Central banks need to focus on some core questions – How will their CBDCs work? Will they only be available to institutions? What problem will they solve beyond simplifying clearing and settlement? – basic questions that have not yet been fully answered. But still, in the field of banking and payments there are no failed experiments. We learn from each one of them. Till then, the acronym CBDC, as the title of this article suggests, may more appropriately stand for Central Banks’ (still not clear) Defence against Cryptocurrencies.

‍The content of this article does not reflect the official opinion of Edgar, Dunn & Company. The information and views expressed in this publication belong solely to the author(s).