The Bank of International Settlements has come out firmly in favor of central bank digital currencies (CBDCs) in a new report—calling them a potentially evolutionary change that can “set high standards for safety and risk management and serve as a basis for sound innovation in payments.”
Central bank digital currencies are a mixture of cryptocurrencies and fiat currency. These digital assets would be potentially although not necessarily blockchain based, but are issued by the government and represent a direct claim on the central bank of the country issuing it. While a U.S. digital dollar is at least five years away, China’s digital yuan is already being tested in four cities.
According to the BIS, which is collectively owned by 62 central banks, CBDCs have the opportunity to trigger a “sea change”—providing households and businesses with new payment options that are safe and efficient.
BIS believes that CBDCs could help central banks unlock financial inclusion, develop fast and inexpensive payment methods, and encourage innovation.
They could also prove to be transformative as an alternative to remittances, which are often expensive—as high as 5% to 10%—in “regions with fewer channels” such as Africa. As well as enabling migrant workers to avoid punishing fees home to poorer nations, transactions could become faster, more transparent, and more convenient.
“CBDCs have the potential to be the next step in the evolution of money, but a thoughtful approach is warranted,” the authors wrote. “CBDC issuance is not so much a reaction to cryptocurrencies and private sector ‘stablecoin’ proposals, but rather a focused technological effort by central banks to pursue several public policy objectives at once.”
And it seems countries are also coming round to the idea. BIS has been tracking speeches from central banks about CBDCs for the past five years—and traditionally, few discussed them in a positive way. But it seems attitudes are finally shifting. In 2020, there have been more upbeat addresses about retail and wholesale CBDCs than negative ones for the first time.
That said, it’s fairly clear from the graph that wholesale digital currencies used for the back-end financial transactions between banks and other financial service providers are more popular—or at least less unpopular—than the retail CBDCs which would be used by the general population.
Big shoes to fill
The BIS is clear that the development of a CBDC designed for public use will be quite a tall order—however, it believes that the coronavirus pandemic could actually serve as a catalyst for these projects to get off the ground. In some countries, cash payments have become increasingly frowned upon amid fears that they could cause COVID-19 to spread faster.
“Technically, a successful retail CBDC would need to provide a resilient and inclusive digital complement to physical cash. As such, a CBDC must have all the features and more that make cash so attractive,” the report’s authors wrote.
This list of features is extensive to say the least. A CBDC would need to be user friendly—meaning everyone from children to pensioners can get accustomed to transacting with them without much hassle. They would need to be resilient to electrical and other infrastructure outages and cyberattacks too, especially if there’s a prospect that they will replace cash one day.
Counterfeiting has long been an issue that has plagued traditional currencies including dollars and pounds, despite valiant efforts from central banks to make notes more secure. BIS stressed that CBDCs would need to be counterfeit-proof if they were to be successful, but also admitted that it can’t be certain that these digital currencies would be immune from such a threat.
And in what could be perceived as a slight toward China, the report added: “Just like other digital means of payment, they need to safeguard the user’s privacy while allowing for effective law enforcement. There are opportunities with CBDCs to improve tracing and potentially improve anti-money laundering compliance. But societies’ preference may differ regarding how to balance better tracing with privacy protection.”
The report’s pointed warning about privacy follows concerns about Beijing’s true intentions when launching its central bank digital currency. Last November, one Chinese central bank executive raised eyebrows when he said the country’s CBDC would achieve “controllable anonymity.”
That delightfully Orwellian phrase suggests that the state will be watching consumers very closely when they are making purchases using the asset—and who knows, they could end up in hot water if they decide to purchase a Winnie the Pooh book on the downlow with their digital yuan.
Evidence to support the Bank of International Settlements’ findings can be found in the frenzied race between countries that want to become the very first to launch a CBDC. China tops this list.
There’s more to this than just national pride, or even making financial transactions cheaper and faster. A true central bank digital currency could threaten the U.S. dollar’s position as the world’s reserve currency. Last summer, Bank of England Governor Mark Carney said one big benefit of a CBDC would be to “dampen the domineering influence of the US dollar on global trade.”
By the looks of things, China is getting ever closer to launching its CBDC. The design for the digital yuan was completed back in January, and trials in four cities commenced in April.
At the start of the year, the Bank of England announced that it had formed a working group with other central banks to look into whether they should issue their own CBDCs. Institutions in Sweden, Switzerland, Japan and Canada—along with the European Central Bank, which oversees the euro—were involved. And in May, there was another big milestone when France’s central bank successfully tested a digital euro for the first time.
Although it seems that the U.S. is beginning to wake up to the benefits of a digital dollar—with Congress holding hearings early in June to explore whether they could improve the delivery of coronavirus-related stimulus payments—it doesn’t appear to something that the Trump administration is pursuing with much urgency. Last December, Treasury Secretary Steven Mnuchin said he doesn’t envisage there being a need for a CBDC until 2025 at the earliest.