The Bank for International Settlements (BIS), the international financial institution which is owned by banks, has urged to consider what ‘central bank cryptocurrencies’ (CBCCs) would look like and how they would operate.
BIS was set up in order to facilitate international monetary and financial cooperation, and can essentially be thought of as a central bank for central banks.
The bank used its latest quarterly update to discuss the effect that the growth of the cryptocurrency market and whether or not digital assets of this kind could be useful to the world’s central banks.
The report states:
“In less than a decade, bitcoin has gone from being an obscure curiosity to a household name. Its value has risen – with ups and downs – from a few cents per coin to over $4,000. In the meantime, hundreds of other cryptocurrencies – equalling bitcoin in market value – have emerged. While it seems unlikely that bitcoin or its sisters will displace sovereign currencies, they have demonstrated the viability of the underlying blockchain or distributed ledger technology.”
The last few years have seen a number of central banks announce that they are actively experimenting with blockchain technology, and the idea of CBCCs has begun to gain traction. There has, however, been little consensus on what form these CBCCs should take, which makes the BIS’ intervention very interesting.
The broad definition of what a CBCC would be that BIS uses in the report is that it would be:
“…an electronic form of central bank money that can be exchanged in a decentralised manner known as peer-to-peer, meaning that transactions occur directly between the payer and the payee without the need for a central intermediary.”
This distinction sets CBCCs apart from other forms of electronic money currently used by central banks, such as reserves and commercial bank deposits.
Interestingly, the report also divides CBCCs into two distinct forms that would serve different purposes: retail and wholesale.
Although they do not currently exist in any form, retail CBCCs have been theoretically discussed by a wide range of central bankers and academics.
The most well-known theory is that of ‘Fedcoin’, or a Federal Reserve-issued cryptocurrency that would have a one-for-one convertibility with cash and reserves. Only the Fed would be able to issue Fedcoins, and each coin could only be created or destroyed if the equivalent amount of cash or reserves were created or destroyed at the same time.
Fedcoins would be similar to cash in that they would be decentralised in transaction and centralised in supply.
The main potential benefit of a retail CBCC along these lines would be the elimination of high price volatility currently common amongst cryptocurrencies. Another important potential benefit would be the removal of the ‘zero lower bound constraint on monetary policy’. This means that if CBCCs were to completely replace cash, depositors could no longer avoid negative interest rates and still hold on to central bank money.
It is also worth noting that while cash is anonymous in that anyone can use it, CBCCs are anonymous be design:
“It is worth recalling that the anonymity properties of cash are likely to have emerged out of convenience or historical happenstance rather than intent.”
There are a number of important risks though, principally the possibility of bank runs occurring quicker if the public were able to easily convert commercial bank money into risk-free central bank liabilities.
Commercial banks may also face a risk if consumers decided to forgo commercial bank deposits in favour of retail CBCCs.
The other potential form of CBCC would be wholesale. Here blockchain technology is used for central bank-operated wholesale payment systems, many of which are coming to the end of the their technological life cycles.
Unlike retail payment systems, these wholesale systems have restricted access. BIS highlights two current projects that are attempting to apply the CBCC model to these systems: Project Japser at the Bank of Canada and Project Ubin at the Monetary Authoirty of Singapore.
The report states:
“A key challenge in any CBCC application is how to transfer central bank money to the distributed ledger. Both Jasper and Ubin chose a digital depository receipt (DDR) approach. A DDR is a claim on central bank reserves held in a segregated account against which the central bank issues digital tokens on the distributed ledger.
“In Jasper, the digital tokens – initially known as CADcoins – are created at the beginning of the day and redeemed at the end. In Ubin, banks acquire or redeem digital tokens at any point during the day and can keep them on the distributed ledger overnight. Hence, transfers on the DLT platform of the Singaporean proof of concept are not restricted to the opening hours of MAS.”
The two projects have been successful in showing that central bank money can be transferred to a blockchain in real time and in sufficient volumes to serve a central banks purpose.
The report concludes by saying:
“…all central banks may eventually have to decide whether issuing retail or wholesale CBCCs makes sense in their own context. In making this decision, central banks will have to consider not only consumer preferences for privacy and possible efficiency gains – in terms of payments, clearing and settlement – but also the risks it may entail for the financial system and the wider economy, as well as any implications for monetary policy. Some of the risks are currently hard to assess.”
Read the whole report here.
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