CBDC – The Emperor’s New Clothes?

There has been a lot of noise around central bank digital currencies in recent years, and central banks continue to investigate the potential of these coins, but are they paying lip service to the concept, or is there a real desire to effect change? Our latest Voice of Experience, from a new contributor with more than 35 years’ experience in the FX industry, suggests all is not what it may seem…

Evangelists argue that cryptocurrencies will change the face of the world’s financial system, despite the significant volatility and high-profile snafus that they have experienced. Major financial institutions and central banks appear to be being drawn into the idea that digitisation is the way forward, and are, to various degrees, embracing the concept. These institutions are also investigating a sub-theme of the crypto/digital revolution, stablecoins, which could, potentially, be even more disruptive for being asset-backed.

At the very least, the growth in stablecoins has prompted the Bank for International Settlements (BIS), and several national central banks, to investigate – and in some cases launch – central bank digital currencies (CBDCs). How far can this work go, though, and more pertinently, how serious are the major economies’ central banks about actually creating and launching digital currencies?

COVID certainly has a lot to answer for and it is, apparently, one of the main reasons that the BIS started looking into CBDCs. It is very difficult to argue with central banks – even more so with the central banks of central banks, the BIS. We do know that the BIS and national central banks have the best intentions, are largely independent, and work really hard keep financial markets efficient through the work of various committees including public/private bodies like the Global Foreign Exchange Committee.

But…Is the BIS (and central banks more generally) investigating a solution for a problem of their own creation?

First of all, what is a CBDC?  It is a Central Bank Digital Currency, which is in essence a cryptocurrency linked to a Fiat currency – i.e. with a fixed value. The idea is to provide total visibility, utilising blockchain technology, allowing payments to be made in a safe and secure way. Both retail and wholesale CDBCs are being considered in various jurisdictions.

In many ways, CBDCs reflect stablecoins, of which there are already several in existence, the first of which was launched in the US in 2014. A stablecoin is in essence a “stable” cryptocurrency as it has a value linked to a definite asset, basket of currencies or similar (whereas there is no such security with cryptocurrencies). So, a stablecoin can be linked to a Fiat currency, or maybe a basket of currencies but can be issued by any private or public institution. A key difference between a CBDC and a stablecoin is the latter does not have the security that a CBDC would provide.

Are the BIS and some national central banks concerned about stablecoins stealing a march on their own plans? More to the point, are a number of central banks content to let stablecoins develop, potentially to be rolled out instead of CBDCs (all while making the right noises about ‘investigating’ CBDCs of course)?

Several central banks are “looking” to regulate stablecoins but at the moment do not, except in the US where they are now covered under the Stablecoin Transparency of Reserves and Uniform Safe Transactions Act of 2022. That said, a lack of regulation did not stop the CFTC fining Tether and Bitfitnex more than $42 million in 2021, connected with allegations their stablecoins were not fully-backed as claimed.

Thus far, much of the BIS’s, and individual central banks’ work, has involved investigation into CDBCs. There are a number of studies and workshops that look into the payment chain, and the various solutions being provided around the globe, such as the CPMI (Committee for Payments and Markets Infrastructure) investigation into PvP (payment versus payment) and its cross-border payments programme initiative. Admittedly it is an area where more cohesion is required, and the authorities are keen to see more efficiencies in this area – one example is the FX Global Code revisions in 2021 where settlement risk mitigation was made a priority.

Notwithstanding the progress being made in some circles, there are some fundamental questions about CDBCs and their development that don’t currently have clear answers

To an outsider there appears to be a focus on many different solutions, with no definitive outstanding product. Is this the BIS hedging its bets – if they look into, and recommend, lots of different solutions then they have to be right when something emerges as the “winner”?

Notwithstanding the progress being made in some circles, there are some fundamental questions about CDBCs and their development that don’t currently have clear answers. Firstly, it isn’t necessarily apparent who would have the responsibility for the maintenance and payment delivery for the CBDC. The central bank would maintain the accounts and deal with payments – but is this the job of the central bank?  Don’t they oversee the market/commercial banks rather than control it as such?

It could be argued that this would impact upon the integrity of the central banks or even skew their focus relating to markets (and their domestic economies on adoption of a retail CDBC). A central bank managing a CBDC may use the information to influence their policy and provide the government with what is essentially privileged information. This could quite easily impact on credibility – a core requirement of any central bank.

The CDBCs that have been launched have the maintenance outsourced to financial institutions and payments service providers – controversially in Nigeria to a company domiciled outside of the country. This outsourcing could be seen as providing a commercial service rather than a gold-star central bank service. It isn’t clear that this works either because concerns about the privacy of information could inhibit usage and confidence.

All of the central banks are watching what happens in this space, but few are talking hard action – who will be the small child that actually voices that the Emperor is naked?

We should also contemplate whether CDBCs are really being considered as a natural progression from crypto to stablecoin to CDBC, each one being more secure than the previous. Could it be central banks are actually more concerned about losing some of their authority over the part of the monetary system?

As of March 2024, three countries had a functioning CBDC: the Bahamas, Jamaica, and Nigeria. The Eastern Caribbean Currency Union halted its CBDC for technical reasons and started a new pilot program. It is interesting that these are small economies where the retail impact may be particularly useful in eliminating domestic financial fraud.

Aside from that, 134 countries, representing 98% of the world’s GDP, are currently “looking into CBDCs” and many have already said that they will be looking further into it in the coming years. Some are in trial and it is likely that more will be issued this year, however, few, if any, major economies are anywhere close to issuance of a working or trial CBDC. It appears that these economies have majorly paid lip service to the BIS – no-one ignores the BIS – by in essence doing everything required of them by participating on the working groups and conducting their own studies.

It is sometimes difficult to understand exactly what central banks think.  Reading through some of the reports and press releases they are careful not to discount a CBDC but are also not committing to one. Phrases such as “we are looking closely at the idea of a CBDC” (UK) and “have made no decisions on whether to pursue or implement a CBDC” (US) are quite typical.

In addition, the Banque de France and others initiated a series of experiments with the European Central Bank in 2020 and appear to be actively looking at delivering a CBDC. In a speech on 25 April, however, the Banque de France’s first deputy governor, Denis Beau, outlined a good case for CBDC, but also pointed out that, “these trends could challenge the role of central bank money in anchoring  the stability of our payment system and financial market system”, which is not an inconsiderable concern. Beau stressed “that the decision to issue a digital euro has not yet been taken” and his conclusion focused on the resolve of central banks to support innovation.

And this is probably the crux of the issue; support goes to a certain point only and most central banks seem reluctant to fully commit. This can lead an outsider to believe that it looks like a case of the Emperor’s New Clothes. All of the central banks are watching what happens in this space, but few are talking hard action – who will be the small child that actually voices that the Emperor is naked?