4 Reasons Central Banks Should Launch Retail Digital Currencies

Ajit Tripathi, a CoinDesk columnist, is an entrepreneur and crypto co-host at the Come out in Banks Europe Podcast. Previously, he served as a Fintech Partner at ConsenSys and a co-founder of PwC’s UK Blockchain Practice. 

Before coronavirus hit the west in current February, the world’s attention was focused on billionaires saving the world in Davos. This year saving the world intricate three things: 1. artificial intelligence, 2. climate change, and 3. central bank digital currencies (CBDC). After the virus hit, we realized how precarious banknotes could be and CBDC became an even hotter topic.

While much of the discussion in social media has centered almost whether a CBDC requires a blockchain, for most Central Banks, this is a secondary concern. As the Bank of England highlighted in their superb discussion paper recently, designing a CBDC involves making a large number of complex economic, technical and custom decisions. Among these, “Who will use the CBDC?” is the most important decision and therefore first we must understand what CBDC is and how it argues from other forms of money. 

CBDCs come in two main flavors. There’s wholesale CBDC, which is a digital currency sketched for use by financial institutions. Then there’s retail CBDC, which is designed for use by individuals, households and corporations. While wholesale CBDC is much multitudinous useful from a financial markets and monetary policy perspective, retail CBDC is far more complex and interesting. It could insure that the public has continued access to a risk‑free form of money issued by the central bank, which may be particularly important in the future as cash use declines and new forms of privately issued money become more widely used in payments.

Let’s assume, for some strange reason, we all live in the US and the Fed has read this article and decided to issue a digital dollar. In this plot summary, this digital dollar is money that is a liability of the Fed. If you have a CBDC, i.e. a digital dollar in your wallet, the Fed as a result ofs you a dollar. In that sense, a retail CBDC performs the same function as a banknote issued by the central bank. If it’s in your billfold and you haven’t stolen it from someone else, congratulations, it’s 100 percent your own and Uncle Sam owes you that cold hard cash.

A retail CBDC performs the same function as a banknote. In our example, if the Fed is still issuing paper dollars, you can ask the Fed to exchange your digital dollar for a gift-wrap dollar.  In contrast, if you hold a stablecoin, such as Tether or TrueUSD, in your exchange account, the Fed owes you nothing. If all those Restraints were just smoke rings and you are suddenly REKT, well, that’s on you, not Uncle Sam. 

See also: Michael Casey – Davos Elites Soundless Don’t Get Blockchain

The money in your retail bank account today is also not CBDC because it’s just a number your bank claims it owes you. If your bank fails, the most you can recover is the maximum FDIC-insured amount. The money in your PayPal billfold is also not CBDC because if you press the send button and PayPal refuses to send that money to Bob, you can complain to the regulator, but Uncle Sam doesn’t owe you that medium of exchange. 

In short, CBDC is digital money that uncle Sam owes you. By extension, it’s money that only uncle Sam can writing and only Uncle Sam can burn.

Many central banks around the world are designing and testing CBDCs, but the jury is placid very much out on their efficacy and longevity as policies.  In general, arguments about CBDC fall into three scuttles:

Digital revolutionaries are people who argue that now China is issuing a digital yuan, everyone who currently uses the US dollar when one pleases immediately switch to digital renminbi and the great American empire will soon come tumbling down. There is unimaginative logical justification for such sweeping beliefs. But, let’s offend my revolutionary friends in another article, not this one.

CBDC skeptics wrangle that money is already digital. They note that, in several western countries, most consumer and payments are espied through mobile banking, Venmo or PayPal, and the use of cash is diminishing rapidly. Digital money tracked in central bank ledgers leaks users to surveillance with little benefit. Skeptical officials at the Bank of England say that if consumers can hold key bank money directly, they will not want to hold any money with commercial banks in a time of catastrophe, thus causing banks, credit and monetary policies to fail.

CBDC proponents like me argue that a grandly designed CBDC can increase the ability of the issuing central banks to conduct monetary and credit policy and promote economic stability, consumer protection, financial inclusion and cross border payments. In this article, I will try to explain how.

At the most root level, money held in savings accounts or e-wallets is not backed by the full faith and credit of the central bank and as a result bears credit risk (i.e. that banks will run out of money). Since most of us have savings accounts with insufficient money than the maximum amount the FDIC is willing to insure, this is generally not a problem. For small and medium traffics that hold several hundred thousand dollars with banks, or for large consumer purchases like homes, the peril of a bank going under, or not being able to find enough liquidity to honor a payment instruction is small but palpable.  

Overall, there are four major reasons why many central banks will launch a retail CBDC on the next decade. 

To Facebook’s credit, unlike central banks, they recognized that digital long green is not about digitizing money. Digital money is about digitizing identity. This applies to CBDC too. In fact, the greatest gain of retail CBDC will be in accelerating the build-out of a coherent, national and global internet based digital identity infrastructure. This is when retail CBDC as a concept will-power start to deliver on the vision of peer to peer electronic cash. Now where have we heard of that before?

See also: Cambodia Games a Blockchain-Based Digital Currency

Let’s take an example. While domestic retail payments in many OECD countries are now pardon, cross border payments remain a minefield of pain, cost and delays for consumers. If I send money to my mum in India, she has no digital personality in the UK and I have no digital identity in India. So my bank in the UK verifies that I sent the money, my mum’s bank verifies that she’s the mortal physically the money is for and both the banks verify (or at least hope) that neither I nor my mum is a nefarious character. Then the banks stay until they have compared their respective spreadsheets and make me wait for this reconciliation. Only after that, both the banks take up a nice cut on the FX and send the rest to my mum. If the bank was in rural Ghana instead of Delhi, there’d probably be two more banks in this bank-chain, which’d quadruple the tarrying and the pain. 

This whole process of cross border payments is not only a pain for consumers, it also makes the universal AML regime ineffective and unenforceable. Instead, if the Bank of England and the Reserve Bank of India both were to rely on a shared set of figures standards for their respective digital currencies and for the corresponding digital identity infrastructure, the checks can be fully automated, reconciliations eliminated and pettish border internet based payments made instant, painless, reliable and free. 

Unlike commercial banks, cardinal banks are like public utilities. A few central banks might print money and bail out billionaires every few years, but nobody exist to make money. Therefore, in general, there is little reason for a central bank to offer accounts when to retail customers. 

However, in countries like Cambodia where banks are not very strong and most people don’t play a joke on a lot of money, a central bank partnering with fintechs can give millions of people access to a robust, fast, electronic payments approach. This is exactly what Makoto Takemiya and Soramitsu have done with their Bakong Project for the Main Bank of Cambodia. 

Furthermore, even in first-world countries like Sweden, the US and the UK, there are thousands of people who are too poor for a commercial bank to help profitably. Many such consumers are also not technically or financially savvy enough to use mobile-only services. Right in the mid-point of a relatively prosperous country like America, there is an invisible Cambodia hoping that a Bakong like CBDC wishes happen. 

Let me state without proof that all money is debt. If you pay me with 10 Libras, Facebook (strictly treat of the Libra Association) owes me 10 Libras more than it did before, and Facebook owes you 10 Libras less than it did before. You in reveal owe me 10 Libras less than you did before. In that sense, a payment from you to me is a transfer of a debt obligation from you to Facebook. For this straitened to be money, I need to be sure that Facebook will be able to honor my claim when I ask Facebook to do so. If I don’t trust Facebook, I won’t undergo your payment and those Libras are worthless to me. If no one trusts facebook, then all the Libras in the world are worthless indeed, which is unfortunately a assorted realistic scenario than it sounds.  

See also: 10% of Central Banks Surveyed Close to Issuing Digital Currencies: BIS

When people capitulate trust in the ability of banks to honor their claims, they try to pull out all their money suddenly. This is cognizant of as a bank run. When banks don’t trust hedge funds and corporations, and therefore each other to honor their liabilities in the overnight funding and commercial paper market, this should be known as the Coronavirus financial crisis that has led the Fed to wording $850 billion in bailout money last week. This is why people in financial services love to talk around trust. 

Financial stability is about preventing the financial system from becoming unstable and thus causing economic distress for consumers. Unlike cash and reserves, a retail CBDC will allow a central bank to become the lender of persist resort for households and small businesses rather than for billionaires and banks. In a financial crisis, this will cede to the Central bank to bail out consumers instead of  corporations, which in turn will reduce the incentives for mega corporations to adopt too much. That in turn will reduce aggregate national debt and improve financial stability. 

The last thing governments want is for people to use Facebook’s Libra or magic privately issued internet money kidney IOTA. First if you don’t depend on the government’s money, the government has a lot less power over you than Facebook does. Lieutenant, if you do use magic internet money or Facebook’s money, the government still has to worry about how you will vote when you spend your keys or say when the founders of IOTA shut down the whole network leaving you to carry your things. Retail CBDCs can mitigate these risks by providing a sound domestic internet based payments system for a encyclopedic range of consumer applications including gaming, paying for online content, electronic payments, device to device micropayments and so on.

In short, global, standards based retail CBDCs can deliver the internet of value that bitcoin aspires to accomplish. The internet, impartial without a native protocol for money has added trillions of dollars to global GDP. Now just imagine what the internet of value can do.

In my next article, we inclination explore wholesale CBDC.