Central bank digital currencies, using an electronic record or digital token to represent the virtual form of a country's fiat currency, could offer a range of benefits, according to a research report by money management firm Bernstein.
The report argues that in an environment where more than half all payments already happen digitally, the modernisation of the global payments system is inevitable and essential for many reasons including financial inclusion, payments stability, efficiency, and monetary policy implementation.
"This becomes even more important as the blockchain technology unleashes a new wave of value creation and industries which are powered by their own native digital tokens. In the absence of a central bank digital currency, which can provide easy on-ramps to crypto, stablecoins will continue to grow. If unregulated, stablecoins pose many risks for monetary policy, anti-money laundering/ know your customer, and consumer protections," Bernstein says.
A stablecoin is a type of cryptocurrency that attempts to offer price stability and is backed by a reserve asset.
"It is not a coincidence in our view that central banks only began to take CBDCs [central bank digital currencies] seriously after Facebook announced its Libra project, which catalyzed an arms race for CBDCs. As per a Bank for International Settlements survey, over the last four years, the percentage of central banks interested in a CBDCs project increased from 65% to 86%. Only central banks in very small countries are currently not looking at CBDCs as per the survey."
Speaking at a press conference last week, Christian Hawkesby, Reserve Bank of New Zealand (RBNZ) Assistant Governor and General Manager of Economics, Financial Markets and Banking, said the RBNZ is among the central banks actively researching CBDCs.
"We have a money and cash department which is in part dedicated to thinking about things like that. So we're working on it and we're planning to say more about it through the course of this year," Hawkesby said.
Meanwhile in its report, Bernstein asks the question what can a digital currency do that a fiat currency can't? It notes that we're in an environment where most consumer-to-business, business-to-business, and bank-to-bank payments are already electronic.
"A digital currency can perform a variety of functions including:
1) Driving financial inclusion (especially in an environment with lower cash usage and lack of bank account access for everyone) – CBDCs could essentially act as a replacement for cash in the digital world,
2) Increasing efficiency through programmability features (e.g., automatic execution of certain transactions on pre-defined conditions),
3) Better implementation of monetary policy (e.g., potential to charge negative interest rate which is impossible with cash),
4) Modernization of domestic payments infrastructure which could operate on 24x7 architecture vs. fiat dollars which are tied to legacy infrastructure," says Bernstein.
In a deflationary environment CBDCs could allow central banks to impose deeply negative interest rates, Bernstein says, adding this would also require broader policy decisions such as wealth transfer from savers to borrowers.
"A second macro consideration, though one firmly in the camp of politicians rather than central bankers, is wealth taxes. A negative interest rate can be thought of, in a sense, as being a wealth tax. A post pandemic environment that is set to see starkly greater inequality is likely to see greater calls for wealth taxes. By limiting the ability to withdraw cash CBDCs could enable such wealth taxes, though we note that a negative interest rate is only a wealth tax for investors who hold very short duration assets – i.e. cash – while it potentially boosts the value of equities."
"But this brings in other policy concerns that go far beyond the narrow topic of just digital currencies. There would have to be a huge debate about what this does to the relative wealth and power of savers vs creditors. There has already been a debate about this in Germany, it would likely only intensify if CBDCs were created. Before people get too excited about the technological possibilities this policy debate needs to happen," Bernstein suggests.
In terms of cryptocurrencies, Bernstein says the launch of CBDCs could make them seem more mature and accepted. But there is also potential for a clash.
"For example, if central banks wanted to force rates deeply negative then bitcoin would become very useful as a way to shield capital from such a rate. However, it would be so useful in that it could get in the way of the implementation of monetary policy and therefore there might be a call for its use to be restricted."
Then there's geopolitics, with the dominant role of the US dollar since World War II, and "existential questions" of monetary sovereignty.
"The dollar is pre-eminent in international payments. However, the ability of the US to 'weaponise' the dollar, the pick-up in demand for gold from central banks such as China and Russia in the last decade and some of the growth of use of cryptocurrencies point to a demand for alternatives. This could force G10 [Group of 10] countries, especially the US, to pre-empt such a move, e.g. by China, and establish their own digital alternative. There could also be a more general concern here of the need to maintain monetary sovereignty in the face of competition from cryptocurrencies or foreign digital currencies," Bernstein says.
The report goes on to suggest that although modernisation of global payments infrastructure via CBDCs poses threats to almost all incumbents including the payment networks, central banks may ultimately partner with these networks to get scale, ubiquity and utility, and to avoid the cost of creating a new payments infrastructure. In terms of payments networks, Bernstein's talking about tax minimisers Visa and Mastercard, plus the likes of PayPal and Square. In fact some central banks are already working with payment networks, with Visa and Mastercard having a long history of being adroit about partnering with threats to their business.
"Mastercard recently announced a collaboration with the Central Bank of the Bahamas to instantly convert their digital currency into traditional Bahamian dollars for usage in retail payments. Both networks are proactively engaging with the governments on design considerations for the digital currencies. Visa recently published a technical paper outlining an approach for offline payments on CBDCs. Mastercard also recently launched a CBDC testing platform."
"Interestingly, both Visa and Mastercard have recently announced capabilities to settle stablecoins on their networks – a suite of capabilities and partnerships, which might come in handy if/when CBDCs are widely launched," Bernstein adds.
The report also suggests that on balance CBDCs are positive for digital wallet providers such as PayPal and Square, suggesting they will likely position themselves as CBDC retail distributors.
"If successful, this will further solidify their positioning as financial super apps, with huge implications for revenue and value per user. Being large distribution platforms of CBDCs could be a big deal for user growth, engagement, cross-sell of financial services, and reduction in legacy payment costs, which eat significantly into gross margins. In its recent investor day, PayPal said that it is looking to engage with governments on CBDCs."
Despite all the potential, Bernstein says it's possible that most CBDCs could never see the light of day, with central banks pursuing different options.
"Most central banks haven't yet decided whether they will launch CBDCs. Central banks may also simply look at improvements, e.g. on digital identity, universal access, speed, 24x7 availability, on ramps to digital markets to existing fast/real-time payment systems around the world. It is possible that many central banks may eventually choose to create a better/more stringent regulatory framework for stablecoins which, when better regulated, may help achieve similar policy goals."
(Note, AEs stands for advanced economies, and EMEs stands for emerging market economies).
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