The topic of Central Bank Digital Currency (CBDC) is gaining momentum. Across the globe, many CBDC initiatives aim to digitalise payments, support financial inclusion, make cross border payments faster and cheaper, support fiscal transfer, etc. What is firing up discussions around CBDC and why is it important today?
Adoption of new technologies and understanding of their huge potential to support and stimulate our life has caused the world to change a lot in the last year. The current pandemic has triggered the decline of cash usage to avoid getting the virus and safeguard the most vulnerable ones (health-wise). Economic wise, as many governments wanted to protect their citizens and directly stimulate the economy down to every citizen, they offered ‘helicopter money’ via digital wallets.
I had a really enjoyable time chairing the “futures” panel in the closing plenary of Intergraf’s Security Printers 2016 in Seville. This is a conference for the people who (amongst other things) print banknotes so I had a fun time behind enemy lines learning about paper, ink, substrates, polymers, foils and special machines that print serial numbers.
One of the topics that came up on the panel was the role of central banks as currency issuers. I think this is a pretty interesting topic because it may be that the switch from physical to digital currency will change the way that the medium of exchange is managed. As Marilyne Tolle from the Bank of England noted on their “Bank Underground” blog recently, one might imagine a central bank-issued electronic money that she labels “CBCoin”:
If households and firms were given access to CBcoin accounts at the CB, banks’ dominant role as providers of payment services would be called into question.
Indeed it would. Note also that Marilyne is clearly describing a digital currency not a cryptocurrency, but that’s by the by. Right now, money reaches the public through commercial banks, a practical structure that stems from the banks role in providing payment services. In response Marilyne’s hypothetical example, I might observe that not only is there no fundamental economic reason why banks should be the dominant providers of payment services, there is no fundamental economic reason why they provide them at all — see, for example, Radecki, L., Banks’ Payments-Driven Revenues in “Federal Reserve Bank of New York Economic Policy Review”, no.62, p.53-70 (Jul. 1999) — and there are many very good reasons for separating the crucial economic function of running a payment system to support a modern economy and other banking functions that may involve systemic risk. Marilyne goes on to note
The conflation of broad and base money, and the separation of credit and money, would allow the CB to control the money supply directly and independently of credit creation
As far as I can tell, this would be a good thing. But we must recognise that impact that it will have on commercial banks. According to the management consultancy McKinsey (2016), global payment revenues are around $1.7 trillion (and will be $2 trillion by 2020) and these account for around 40% of global bank revenues! So if payments go away, banks are going to have to think of something else to do instead.
I have a suggestion (you know what’s coming, don’t you) and I think it’s a practical one. The Security Printers panel was actually called “the future of banknotes and identity” which I think shows us the way forward… If you can move money from anyone to anyone else, instantly and for free with final settlement in central bank money, and this is provided as a utility service provided by the central bank, then the fraudsters who are plaguing the Faster Payments Service (FPS) in the UK will have a field day. Perhaps, then, the role for the central bank is to issue the digital currency and run the digital currency payment platform that will (in a fairly short time I would think) replace commercial bank (and all other) payment services. Not so much CBCoin as CBPesa, since it would manage balances not coins.
However, the central bank doesn’t want to do KYC on millions of people, run mass-market authentication services, perform AML checks, manage black lists and run interfaces with law enforcement and so on. Just like Bitcoin, the central bank accounts would be pseudonymous. The central bank would know that account no. 123456789 belongs to a retail consumer, but not which consumer. It would know that account no. 987654321 belongs to a retailer, but not which retailer. This way the central bank could generate a dashboard of economic activity for the Chancellor to look at when he wakes up, but not routinely monitor what you or I are up to.
It would be the commercial banks provide the services linking the pseudonymous accounts to the “real” world (and get paid for them). Then your Sterling bank account will just be a pass-through API to a central bank digital currency account (what Marilyne calls the “CBCoin Account”) because my Barclays current account and your Lloyds current account are just skins on the Bank of England UK-PESA platform and the commercial banks can chuck away their legacy payment systems and focus delivering services that add real value.
Commercial banks will then have an important function as the vaults that look after identity, not money. As I told the panel in Seville, money and identity look like very different topics, but in reality they are the same.
In the speech that the Governor of the Bank of England eh, Mark Carney, didn’t give to the Mansion House in June he devoted some considerable time to the general topic of shared ledger technology, even going so far as to say that
In the extreme, a [shared ledger] for everyone could open the possibility of creating a central bank digital currency.
I am not sure that I completely follow Mr Carney’s logic here and I don’t have the benefit of the expert advice that he must have received in connection with this statement but as far as I can tell, there are two entirely separate issues to examine here. The use of the distributed ledger for RTGS, which is the context in which it is mentioned earlier in Mr. Carney’s speech, is wholly unrelated to the provision of a central bank electronic currency and whether it might or might not be a good idea for the Bank of England to create such is nothing to do with the technology.
I suspect that the confusion may have arisen because of the tendency amongst management consultants (and others) to conflate the two entirely different kinds of electronic money: a crypto currency and a digital currency are very different things. If Mr Carney were genuinely suggesting that one of the scenarios under consideration by the Bank of England is that it abandons its responsibility for managing the creation of money and instead turns to a crypto currency, even if it is a crypto currency that is produced as a byproduct of a double permissionless shared ledger spawned by the Bank of England itself, then the value of that currency would not only be beyond political control it would be beyond the Bank’s control and one might imagine the Bank to be somewhat redundant in such circumstances.
The Bank of England is absolutely right to be exploring this new technology and I certainly think that it has something to offer. But that does not mean that the Bank of England is going to start using Bitcoin as a settlement system or that bitcoins will replace Sterling!
On the other hand if Mr Carney were genuinely suggesting that one of the scenarios under consideration by the Bank of England is that it creates a digital currency, then I say more power to him. I cannot think of a single reason why such a digital currency would be a crypto currency or why it would be in any way related to the shared ledger used to process the payments, but that doesn’t mean it wouldn’t be a cracking idea. A digital currency platform with right APIs in place (providing risk-free, genuinely instant and zero-cost transfers between accounts with final settlement in central bank balances) would be an amazing platform for a Digital Britain.
Remember last year when some Bitcoin chaps apparently used a “freedom of information” request to get hold of Citi’s response to the UK government’s consultation on digital currencies and the like. Apparently, Citi told the government that digital currency is a good idea.
The greatest benefits of digital currencies can be realised through the government issuing a digital form of legal tender. This currency would be less expensive, more efficient, and provide greater transparency than current physical legal tender or electronic methods.
As I have said on a number of occasions, I simply do not see the efficiency of “a digital form of legal tender” as being evidence that the government might issue a UK cryptocurrency as some in the Bitcoin world have said. First of all, in the UK almost all Sterling is already digital other than the rump 3% or so that is needed for crime and tax evasion so it’s not clear the government needs to issue a digital currency at all (they could just let banks and electronic money issuers do it). Secondly, I don’t think government interest in digital currency means anything for cryptocurrency since digital Sterling wouldn’t be implemented using Bitcoins anyway. And thirdly, legal tender is an irrelevant concept in this context.
When I read this report, though, I remember being curious as to whether Citi economists had any input into it. If cash is to be replaced by a digital currency created by the government — rather than by the commercial banks, as it is now — then one might imagine that the economic consequences would be significant. Removing the zero floor on interest rates, for one thing, which is in fact what Citi’s chief economist wrote about in April last year.
Willem Buiter, global chief economist at Citi, is arguing in a new research note that central banks should be prepared to set negative rates… A key reason that central banks can’t set rates as low as they would like is cash. The theory is that savers would take all of their money out of banks rather than be charged a negative rate. What to do? Well, one idea is to get rid of cash and move to digital payments.
Suppose that the government decided to go down this route. (Not as a big bang thing: there’s no need to abolish cash immediately. We can start by getting rid of £50 notes that are really only used for shady purposes and we can get rid of the 1p and 2p coins at the same time.) Whether we leave the digital currency to the banks or to the central bank is a really, really huge political decision. Really huge. What should we do? David Andolfatto, VP at the Federal Reserve Bank of St. Louis, wrote in Newsweek recently that
My own recommendation is for central banks to consider offering digital money services (possibly even a cryptocurrency) at the retail and wholesale level. There is no reason why, in principle, a central bank could not offer online accounts… These accounts would obviously not have to be insured. They would provide firms with a safe place to manage their cash without resorting to the banking or shadow banking sector. They would give monetary policy an additional instrument—the ability to pay interest on low-denomination money (possibly at a negative rate). To the extent paper money is displaced, there would be large cost savings as well.
Now, I have to say that I am extremely sympathetic with this point of view. I rather think that the creation of money should be under government control and there are many reasons for thinking that allowing commercial banks to create money does not always lead to the best possible outcomes for society. But should central bank money be the only money? Probably not, and I’m also sympathetic to the view that David (and other eminent thinkers in the field) puts forward, that having competing currency substitutes would serve to act as a bound on government policy options.
It’s hard (for me) to see what the downsides are in having a central bank supply digital money. Critics might argue that it leaves people exposed to potentially poor monetary policy. This may be true and, for these people, currency substitutes should be available (including Bitcoin).
If people want to use Bitcoin, let them. If people want to use cowrie shells, let them. The only thing that they would legally compelled to use Sterling for would be the payment of taxes. But how should this Sterling be implemented?
In terms of payments, critics might argue that central bank accounts will be permissioned accounts, requiring the release of personal information, application efforts, that KYC restrictions will apply (so not censorship resistant) and so on. To address these concerns, a central bank could go one step further and issue a cryptocurrency (Fedcoin) offered at a fixed exchange rate where payments are cleared using a Bitcoin-inspired anonymous communal consensus algorithm.
This is where I disagree with David. New thinking is needed here, new thinking about the relationship between identity and money. Let’s unpick the three issues he touches on in the paragraph above.
KYC and Permission. Clearly anything that is intended to replace physical cash must be inclusive. That means that there cannot be any KYC, nor any other conventional form of account application process. Personally, I do not see this as a negative. On the whole, I think that society benefits more from having all transactions electronic than it loses from affording a very limited form of economic anonymity for very limited transaction values. You might, for example, allow people to open digital payment accounts at the Bank of England and store amounts up to £1,000 with no identification at all, perhaps requiring only a mobile phone number or a postal address to activate the account. I see this as being a bit like getting a Gmail account! I log into the Bank of England, create a new account in the name of “DaveBirch” and get a message telling me that that account already exists so I choose “DGWBirch” instead. Then, anyone can pay me through the national digital payment system by sending money to £dgwbirch.
I’d also get another account as “Lord Tantamount Horseposture” that I could use for gambling or buying drugs whatever else it is that people do with cash. If I want the account balance to exceed £1,000 then I would have to provide some other form of valid and acceptable identification, such as a Facebook account, and if I want the account balance to exceed £10,000 (the suspicious transaction reporting limit) then I would have to present a passport or something. The point is that everyone should be able to get an account.
These accounts could pay interest and the interest could be negative. I can easily imagine economic circumstances leading to a tiered system whereby accounts below £10,000 pay 0.5% interest and accounts above £10,000 pay -0.5% interest. Why? Because you want people with surplus money to invest it in productive enterprise but you want to help the poor at the same time.
Censorship resistance. Neither the central bank nor society as a whole wants censorship resistance when it comes to value transfer and I cannot see any reason why this would be implemented. I can certainly see the argument in favour of pseudonymity, which is why I would be allowed to have an account in the name of Lord Tantamount Horseposture, but of course that account would be linked to my mobile phone number or my Apple ID or my LinkedIn account or whatever, so that if I were to use that account to fund terrorism or evade tax then the authorities would be able to obtain a warrant and uncover that link. This is what I have previously referred to as a “smash the glass” form of conditional anonymity. So, I might make a bet with someone who doesn’t know who £horseposture actually is, but if that bet turns out to be linked with suspicious activity and a far-Eastern betting syndicate, then the police could easily get hold of me.
Cryptocurrency. Given that I am obviously in favour of such an account-based system, which would have absolutely minimal transaction costs since the transfer of a hundred pounds between £dgwbirch and £horseposture would use absolutely minuscule amounts of resources, and given that I do not see censorship resistance as a requirement, I do not see why cryptocurrency would make sense as a potential implementation. Now, I understand perfectly well that there are arguments in favour: people might for example argue that a single point of failure for this important national resource would mitigate in favour of a replicated distributed shared ledger to defend against cyberattack or (as is traditional in the UK) government incompetence in the procurement and operation of large-scale computer and communication systems. I am open to evidence on this matter, but my first thought is that the cost of maintaining consensus for a system replacing cash on this scale far outweighs the cost of moving from “five nines” availability to 100% availability.
Note also that if censorship resistance is going to be implemented using a cryptocurrency (e.g., Bitcoin) then I simply cannot imagine a scenario where central banks would allow proof-of-work mining to be controlled by anonymous, largely Far Eastern mining pools.
So: imagine something like M-PESA but run by the Bank of England. Everyone has an account and you can transfer money from one account to another by a mobile phone app (that uses the secure TEE in modern mobile phones) or by logging in with two factor authentication to any one of a number of service providers that use the Bank of England API to access the accounts or by phoning a voice recognition and authentication service. Drawing on our experiences from M-PESA, TAP and other population-scale mobile-centric system that we have advised on, I think that this API might actually the most important single thing that a Brit-PESA might deliver to the British economy.
In addition to the obvious benefits to trade and industry, and in addition to the obvious benefits to law enforcement, it would mean that the Bank of England would have a real-time dashboard of economic activity that could be added to the real-time retail payment dashboards of the banks (I’m joking of course: they don’t actually have these) so that when the Chancellor of the Exchequer gets up in the morning he can see exactly what consumer spending was the day before. Exactly. So, Brit-PESA is not only a means to obtain the cost-effective efficiency that Citi referred to but it ought to be a great improvement in helping to manage the economy.
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