Bitcoin was launched with the express goal of eliminating the need for third-party financial institutions in electronic payments. And crypto-loving banking critics tend to reserve special disdain for central banks, which they believe have too much power to meddle in valuations of fiat money.
So it might seem ironic that a number of central banks around the world are exploring the possibility of issuing their own cryptocurrencies in the future.
Such central bank digital currencies, or CBDCs, are getting attention for a variety of reasons, the International Monetary Fund noted recently. For instance, in some societies – especially those like Sweden that have rapidly moved away from cash payments – CBDCs might prove to be a better, more modern alternative to physical coins and paper money. The IMF says CBDCs could also help improve financial inclusion in developing economies.
“CBDC may also help meet other public policy goals,” the IMF notes. “Not only could it reduce the costs stemming from cash maintenance and distribution, and promote financial inclusion, but… it could also protect consumers and strengthen the stability of payment systems where regulation does not adequately contain private monopolies.”
It adds: “Monetary policy transmission is unlikely to be significantly affected and may even benefit from greater financial inclusion with CBDC adoption. Interest-bearing CBDC would eliminate the effective lower bound on interest rate policy, but only with constraints on cash usage.”
In a 2018 analysis of Bitcoin for Bloomberg, CME Group economists Bluford Putnam and Erik Norland discussed the potential for “blockchain-enhanced fiat currencies” to enable policy makers to better fine-tune their economies.
“Blockchain technology has the potential to allow policy makers to issue their own cryptocurrencies that will give them real-time information on inflation, nominal and real GDP,” they wrote. “It will not allow them to peer through the front windshield into the future but at least they can look into the rearview mirror with much greater clarity and see out the side windows of the monetary policy vehicle. This could allow them to create the amount of money and credit necessary to keep the economy growing at a smooth pace more easily than they do today.”
As a recent paper by the UK’s Institute and Faculty of Actuaries pointed out, central banks (CBs) are also studying issuing their own digital currencies out of concerns about a changing monetary system.
“Cryptocurrencies are challenging the traditional pillars of the financial system and against this backdrop CBs are faced with the threat of individuals being able to store, spend and move value without reliance on the fiat currency,” the paper points out. “This is a huge threat to the traditional role that CBs play in monetary policy and so it is little surprise that there is gathering momentum across developed banks to analyse and understand the potential effects of introducing a CBDC.”
However, CBDCs are likely to present as many challenges as benefits.
The University of Luxembourg’s Hossein Nabilou, a researcher in banking and financial law, noted in a recent paper that any attempt by the European Central Bank to issue a CBDC would “face a set of legal challenges that need to be resolved before its launch at the euro area level”. He added: “Resolving such legal challenges may prove to be an arduous task as it may ultimately need amendments to the Treaty on the Functioning of the European Union (TFEU).”
The IMF considered a number of other possible implications in a 2018 discussion note about CBDCs. Among the questions it examined was whether a CBDC might undermine financial integrity, financial stability and banking intermediation, and whether it might harm the effectiveness of monetary policy transmission. The authors concluded that much would depend upon the needs of the country issuing the CBDC, the design of the CBDC and the related policies that are implemented.
Central banks in more than a dozen countries have to date explored the potential for so-called “retail” CBDCs, which could be used by consumers as well as by financial institutions. (Another type of CBDC, a wholesale CBDC, would be usable only by selected institutions for interbank settlements.) Those countries include the Bahamas, Brazil, Canada, China, Curaçao/Sint Maarten, the Eastern Caribbean, Ecuador, Israel, Norway, the Philippines, Sweden and Uruguay. Others that have already investigated the possibility of CBDCs and put the idea on hold or rejected them include Australia, Denmark and the UK.
Among the concerns some of those banks have cited are limited benefits and the potential for bank runs, according to the IMF.
“Operations raise multiple issues,” the IMF notes in an April newsletter. “The technical feasibility of introducing CBDC must still be evaluated, and costs better understood. In part, central banks would have to determine the degree of outsourcing. Most pilots to date have outsourced key operations, albeit under close supervision. These include digital note production, ledger maintenance, electronic wallet provision, ‘storefront’ operations, and help desks.”
Beyond such operational issues, security concerns also need to be resolved. “Robust governance and risk management standards would have to be developed,” the IMF adds. “For example, CBDC issuance will put a premium on state-of-the-art cyber risk management, given the huge operational and reputational risks involved.”