As central banks race to pilot ‘national digital currencies’, Luke Bartholomew, senior monetary economist at Aberdeen Standard Investments discusses the implications and asks, will we see a UK ‘Britcoin’?
Some of the best economic and banking brainpower is currently being directed at one very pressing problem – how to head off the threat to the world’s financial systems coming from the burgeoning asset class known as cryptocurrency.
Almost every one of the world’s central banks is currently researching, or even piloting, central bank issued digital currency as a way to keep control of the money supply and interest rates, and preserve financial stability. However, these central bank digital currencies could also cause significant financial upheaval.
On the current timetable, central banks that manage the money system for 20% of the global population will have issued a form of ‘national’ digital currency within a few years – although no one can yet predict how this experiment with the world’s currencies will play out.
Research into creating national digital currencies is currently underway at the US Federal Reserve and the European Central bank; in April, the Bank of England announced the creation of a taskforce with the Treasury, which is expected to announce a UK digital currency pilot scheme very soon.
The People’s Bank of China is ahead of the game and already at the pilot stage. It has created a national crypto currency that runs through a phone app. The stated aim is to replace cash, improve financial inclusion and build more efficient payment systems throughout the country. China already has a very sophisticated phone payment network and it could be said that the population has fewer qualms around privacy. Other innovative financial tools are also being investigated by the Chinese central bankers.
So what would a central bank issued digital currency (CBDC) be, exactly?
In essence, it’s a new digital form of money, similar in some ways to Bitcoin and other cryptocurrencies, but issued in the national currency – so we could see a ‘US dollar coin’ or maybe a ‘Britcoin’. It would be digital, and could be tokenised and stored on a digital ledger, like the private crypto currencies, or it could be held in an account with the central bank that may not appear too different from an account with a high street bank.
Two sides of the crypto-coin – opportunities and risks
The benefits to the countries and governments of those central banks creating digital currency may include heading off the current threat from private digital currencies and retaining control of the money supply and interest rates to support economic aims. Central banks could also gain better data on where people are spending their digital currency; people could be given ‘helicopter money’ more easily, and be incentivised to spend it; taxes could be auto-deducted. A central bank digital currency could also give more flexibility around negative interest rates if it also involved the abolition of physical cash. This may help stimulate economies in downturns.
There could be benefits for holders of central bank digital currencies – they should be a risk-free asset as, unlike commercial banks, central banks can’t go bust. CBDCs should also allow for much cheaper and speedier payment processes. If central banks around the world co-operate with one another, moving money internationally should also be easier and cheaper.
However, there are undoubtedly risks to this brave new digital currency world and some of them potentially frightening. Central banks issuing their own currencies could destabilise the entire banking sector. Will people want high street bank accounts if they can hold a central bank digital account that’s cheaper and safer? In time of crisis, people might be likely to move money out of their bank account and into their central bank account, accelerating bank runs. If CBDCs pay interest, they’ll set a floor below which commercial banks won’t be able to drop. This risks turning banks into investment companies with less flexibility to lend to growing companies. It could also undermine the straightforward access to credit currently enjoyed by households and businesses.
Other downsides for holders of CBDCs include a loss of anonymity. The state could gain much more oversight into people’s spending. This could lead to tax confiscations and much greater state control of individual’s money. The People’s Bank of China is already suggesting the issue of ‘depreciating currency notes’ to incentivise people to spend.
The transition to CBDCs has the potential to be volatile. To avoid unleashing a wave of destabilisation, almost all central banks want to limit the attractiveness of their crypto currency and its availability, so they are most likely to make the currency available via commercial bank accounts.
But not acting over the rapid growth of private cryptocurrencies would also be destabilising, as central banks risk the world’s population moving over to crypto currencies that are entirely in private hands and beyond government control.
The most likely scenario in the short-to-medium term is that private cryptos will continue to expand, and there will be something of an uneasy co-existence between them and CBDCs. There may well be regulation at the margins of crypto, as has been seen China. Over the longer term, CBDCs may supersede, and private crypto currencies and even commercial banks could be squeezed out.
The alternative, and potentially more destabilising situation is that CBDCs are not attractive enough to stop the march of unregulated cryptos, as people quickly adopt new private platforms and currencies. Policymakers face losing control of the financial and payment system, and currencies such as private ‘stablecoins’, which are supposed to convert at a fixed rate with existing national currencies, may become dominant. This scenario is less likely, as it involves regulators not acting and not pursuing own interests, but it is possible. So it’s hardly surprising that all the best economic and banking firepower is working on robust solutions to these very pressing problems.