A summary of the webinar of May 18 2022 entitled Are central banks thinking radically enough about CBDCs?
CBDCS are widely expected to be the key to unlocking the potential of tokenisation as a technique for transforming payments and securities issuance, trading, servicing and safekeeping, and for bringing a host of new asset classes – privately managed assets, commodities, fine art, collectibles, royalties and other income streams – within reach of a wider range of investors. So why are they taking so long to appear in the major financial markets?
On the last Future of Finance webinar on CBDCs in November 2021 (“The waiting is over”) there seemed to be a sense that there was significant momentum in the number of CBDCs in the pipeline and more clarity about what they might actually look like. CBDCs would be retail, central banks would provide the infrastructure while commercial banks and other service providers would provide the distribution in a competitive environment. Globally, CBDCs were expected to play a major role to play in meeting the G20 goal of cutting the costs of cross-border payments.
Six months later, some of that forward momentum and clarity looks to have been lost. Has it? Or have the last six months been a period of deepening, especially of pilot schemes? Have CBDCs embarked on a more nuanced, and thereby more opaque, process of progression? Are central banks undertaking a more detailed exploration of use-cases to see which ones actually work? Do CBDC projects just have long lead-times?
What trajectory have CBDCs followed since 2020?
If we look at the history of CBDCs since January 2020 the growth in two and half years is explosive; from 33 live projects to almost 100 now (see Table). Pilot projects, which are the last stop before launch, have nearly tripled from five to 14. They require real commitments of time and resources. Proofs of Concept (PoCs), many of which expand into Pilots, have also expanded to 15 in total.
Number of countries with a CBDC project live
|01 January 2020||0||5||7||21||33|
|30 June 2020||1||7||8||20||36|
|01 January 2021||1||7||9||50||67|
|30 June 2021||2||11||11||50||74|
|30 November 2021||3||11||12||50||82|
|01 January 2022||3||13||13||58||87|
|06 June 2022||3||14||15||64||96|
Source: CBDC Tracker, Atlantic Council
Retail CBDCs have always been more numerous, taking off after Facebook announced its Libra project. Retail CBDCs still account for 76 per cent of all projects by number, though wholesale CBDCs are equal in number at the Pilot stage. Wholesale CBDCs have certainly attracted more attention recently – partly as more of them are reaching the later stages of project and partly because of the proliferation of high-profile cross-border trials of CBDCs – which are all wholesale.
Yet the fact remains that there are only three functioning CBDCs (depending on whether you count the Eastern Caribbean Central Bank (ECCB) digital currency, which ran into a technical glitch in June 2022, as a CBDC). No new CBDCs have gone live since Nigeria announced the eNaira in October year. This is encouraging a sense of drift, especially in the major markets. No G7 country has a Pilot or a PoC or is committed to launching a CBDC. The G20 states have between them just three Pilots and two PoCs – globally, there are 15 of each.
What is slowing CBDC adoption down?
The consensus among industry experts favours the notion that CBDCs are following predictable paths, especially in terms of timelines. The retail e-Krona, for example, was initiated by the Swedish central bank in 2017 and is now (five years on) in a Pilot phase. When it was launched the projected timetable was seven years.
How often are major projects delivered on time? A report last week said the e-Krona has successfully been integrated into the Swedish payments system but still faced challenges around Anti-Money Laundering (AML) and Countering the Financing of Terrorism (CFT) obligations. It was also discovered that the eKrona may require the Swedish constitution to be changed. So even successful CBDC projects run into problems.
The problems with the ECCB project notwithstanding, the eKrona issues underscore the fact that in a modern economy solving the technical issues of a CBDC is the easy part. Solving the legal barriers within a single country is a major effort. Overall, a CBDC is a multilateral effort requiring input and support from governments, politicians, the finance and legal sectors and civil society. The governance, privacy, financial inclusion and distribution issues are large and complex.
In a smaller jurisdiction like the Eastern Caribbean is unfortunate to have a technical glitch on a phased launch, but tolerable. By contrast, no central bank in a major economy could afford even a temporary technical failure in a phased roll-out of a CBDC or even a demonstrable lack of usage. For the Federal Reserve, the European Central Bank (ECB), the Bank of Japan and the Bank of England, failure is not an option. One party involved in CBDC discussions at the Federal Reserve summed up the goal as to build something that will last for decades and be able from the outset to process tens of thousands of transactions per second. It is a different standard for measuring success compared to, say, settling cryptocurrency transactions.
In fact, in major markets, the debate between wholesale and retail is giving way to a more interesting question: how does a CBDC fit within the wider financial system? It is not inconceivable that a CBDC is available in wholesale form only, while the retail aspect might be handled by a commercial Stablecoin issued by a regulated entity. Some analysts think current retail options, combined with deposit insurance, may make a retail CBDC redundant altogether.
What a jurisdiction needs also affects the design of a CBDC. The ECCB and e-Krona CBDC projects, for example, could scarcely be more different in the problems they are addressing. The e-Krona is a response to Sweden being the country with the lowest usage of cash in the world. It is designed to give consumers who want to continue to use cash a means of doing so. Economically, it is not worth printing cash and retailers are increasingly refusing to accept it.
In the Eastern Caribbean, by contrast, a CBDC is designed to make payments more efficient. The area lacks an efficient means of payments between individuals and businesses, and users face costly payments charges to move money between member-states.
What about using CBDCs to make cross-border payments cheaper and faster?
The potential of CBDCs to transform cross-border payments date back to the start of Project Jasper by the Bank of Canada in 2016. Since then, eight projects involving 15 central banks have proved that wholesale CBDCs can be used to settle cash payments and the cash legs of securities transactions across national borders.
The interest is not surprising, since the high cost, slow speeds and lack of transparency of cross-border payments are a major focus of the G20. The success of some Pilots in demonstrating cross-border payments and securities settlements, plus the deep involvement of the Bank for International Settlements (BIS) alongside the 15 central banks, gives cross-border uses of CBDCs official blessing.
The projects have shown that bilateral bridges are possible even if making payments systems in each country interoperable requires legal as well as technological investment. Connecting networks so that cash and securities trades can be settled without payments across networks, or requiring banks to be supervised by additional central banks, is the principal goal.
The ultimate ambition of a multilateral bridge would need international coordination of policy and legal frameworks. Organising that degree of cooperation is a major political challenge, for central banks as well as governments. The Federal Reserve, for example, is historically loath to be tied down by international agreements and will be concerned to maintain the supremacy of the US dollar.
Nor does cross-border CBDC development take place in a vacuum. CBDCs are being explored at a time when many central banks are pondering how to build the next generation of Real Time Gross Settlement systems (RTGSs). At the moment RTGS services are not open around the clock, which makes cross-border payments more difficult.
Alternative solutions, such as those advanced by Fnality, aim to allow RTGS account holders to settle payments between themselves 24 hours a day, 365 days a year, adjusting transfers once the local RGTS is open. This “multi-local” approach avoids much of the complexity of cross-border CBDCs and related questions of central bank supremacy.
What is the role of Stablecoins in a world of CBDCs?
There is a sense that Stablecoins are just a way to settle the cash leg of tokenised transactions until CBDCs put central bank money “on-chain.”
Certainly, it is hard to imagine a worse month for Stablecoins than May 2022. Terra USD, the third largest Stablecoin, imploded. Its market value fell from US$18 billion at 1:1 to US$110 million at US$0.10. The consensus is that Stablecoins are, well, not stable – and that to write the Terra experience of as peculiar to the algorithmic variety is naive.
For example, the biggest Stablecoin (Tether) holds 0.22 per cent equity against 14.36 per cent of assets in “Corporate Bonds, Secured Loans, Other Investments (including Digital tokens).” Even if the 85.64 per cent held in “Cash and Cash Equivalents” are available instantly, it is not hard to see how Tether too could become unstable. It is interesting that the market capitalisation of the other major Stablecoin (USD Coin) equals its coins outstanding, while Tether trades persistently at a small discount. When Terra was imploding, Tether was trading six times as much as USD Coin. Tether has continued to meet redemption requests, and its assets to decline.
These issues have emerged against a backdrop in which major financial centres are indicating that they plan full-scale regulation of Stablecoins – notably HM Treasury in the United Kingdom in April 2022 and the United States in November 2021 via a report on Stablecoins from the President’s Working Group on Financial Markets.
The likeliest future is one that includes both (regulated) Stablecoins and CBDCs. As with CBDCs in general, specific use-cases will decide the outcome. If a CBDC is not available in a particular jurisdiction or currency, a Stablecoin is likely to succeed. Bit much about Stablecoins will also have to change if they are to be really useful. At present, Stablecoins are 95 per cent US-dollar denominated. Euro Stablecoin issuance is equivalent to just 0.3 per cent of the outstanding market capitalisation of Tether.
Already, two main use-cases have emerged for CBDCs. First, multinational companies are issuing their own digital coin to settle intra-group transactions, including across borders. The J.P. Morgan JPM Coin is used in this way. The Volvo Stablecoin is the major non-bank example of the same phenomenon. It is not a major stretch to imagine a lot of multinational companies following these examples.
The second use case is financial market operators effectively issuing their own Stablecoins as payment tokens. Both the SDX digital exchange in Switzerland and ADDX in Singapore use tokenised fiat currency to cover the cash leg of blockchain-based trades.
ADDX clients hold their cash at a linked account at DBS. When a trade takes place the buyer’s cash at DBS is swapped for tokenised fiat on the ADDX platform to settle the trade. Sygnum Bank in Switzerland also has its own digital Swiss franc (digital CHF) token for its Organized Trading Facility (OTF).
The SDX case is of particular interest. While any bank or market operator can take commercial bank money, tokenise it and create a Stablecoin, this will still ultimately be commercial bank money. But trading systems aim to settle in central bank money, as does most institutional quality business.
In the SDX case, the Swiss National Bank (SNB) allows member-banks to deposit central bank money with SDX, which issues central money-backed Stablecoins. Which blurs the line between CBDCs and Stablecoins. But it may be a glimpse at a future in which commercial banks use wholesale CBDCs in markets and take retail CBDC deposits and tokenise them to provide central bank-backed Stablecoins for settlement purposes.
Could CBDCs be a factor in the Renminbi displacing the US dollar as the world’s top reserve currency?
The determination of China to press ahead with intermediated wholesale and retail CBDCs has been a cause of some concern to other central banks and governments. Some analysts worry a Renminbi CBDC could be the tipping point for the Chinese currency to displace the US dollar as the main global reserve currency.
Despite some questions about how well the Chinese CBDC Pilot is going, its sheer scale (it had 260 million wallets exchanging more than 150 million transactions by early 2022) ensures that it dwarfs anything contemplated by the G7, whose members have no Pilots or PoCs in hand.
Strategically, Western powers do worry that China – and, to a much lesser extent, Russia – are using CBDCs to escape from a US dollar dominated world economy led by a sanctions-happy United States. But the Reminbi share of the 2019 BIS Triennial FX numbers was 4.7 per cent (against 4 per cent in 2016) versus 88.3 per cent for the US dollar. The Renminbi has a way to go.
Continued Chinese capital control restrictions are one reason why, but the reasons why some countries and currencies become dominant in global finance reflects complex factors: time-zone, talent, rule of law and concentrations of specialised services such as insurance and foreign exchange (FX). These cannot be replicated or moved easily. Even a major political event such as Brexit has made little difference to London’s position as a European and global financial centre.
It is unlikely that the speed at which a G7 country adopts a CBDC will materially affect its competitive position. If the eurozone were to act nimbly and produce a world-beating CBDC, it might have some impact – but only until the US dollar responded.
What is the likely impact of CBDCs on the conduct of economic and monetary policy in the future?
One concern in early discussions about CBDCs was that holders of commercial bank deposits would rush to switch to CBDCs, either by moving deposits to the central bank directly or via their current bank. The principal impact would be a reduction in lendable deposits by commercial banks, making credit scarcer and more expensive, and hampering economic growth.
This fear has diminished as central banks have made clear that they view a run on bank deposits as a highly undesirable outcome and that they have tools to manage the risk. Commercial banks may also find ways to utilise CBDCs deposited or entrusted to them – such as Stablecoin issuance or issuance of CBDC-backed tokens – that mitigate the impact on credit. Hybrid intermediated CBDCs are emerging as the model that central banks seem to favour most.
Concern about CBDCs invading personal and corporate privacy remain alive. A programmable CBDC is potentially the recipient of vast flows of information about personal and commercial transactions. In jurisdictions uncomfortable with the idea of a central banks owning a vast general ledger packed with data about money flows, counter-measures would be needed.
These include segregating retail purchases from Stablecoin market settlements, and use of other privacy protections. The data could also be collected but be held not by the central bank but by retail-level aggregators.
There would be benefits to be derived from the data. At the simplest level, it could permit the development of sophisticated credit-scoring metrics (of the kind AliPay has, somewhat discouragingly, developed in China). The data could also be used to improve economic modelling.
The last decade has seen economic policy dominated by monetary policy in general and quantitative easing (QE) in particular. Pioneered by the Federal Reserve, minutes show the expectations of policymakers about the positive effects of QE – the ambition was to stimulate economic activity by forcing banks to lend more to compensate for reduced interest margin – were low.
Minutes also show policymakers were aware of the inflationary impact of QE on asset prices and its impact in exacerbating economic inequality. It is reasonable to say that outcomes were worse than expected in both cases.
Which begs the question: could a programmable CBDC be a better instrument next time stimulation is needed? Essentially, it could act as carefully targeted “helicopter money.” In short, a CBDC could provide stimulus were it is needed, because it is guided by massive flows of real-time information. It is certainly less of a blunderbuss than using QE to prod unwilling banks into lending more.
Interestingly, a programable CBDC would instrumentalise CBDCs as a policy delivery tool. Monetary policy would shade not fiscal policy, with the central bank collecting the data and providing analytical support as well as issuing the CBDC. The ultimate policy and targeting decisions would still be made by the government: HM Treasury in the United Kingdom or the Department of the Treasury in the United States.
In sum, CBDCs create the potential for governments to use programmable money as an active tool in the implementation of economic policy, not just monetary policy.
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