In the past few years, reoccurring news about the volatile market behavior of the bitcoin, the largest private digital currency by market capitalization, have greatly increased public attention and interest towards cryptocurrencies in general. Meanwhile, an increasing number of experts in the financial sector have openly expressed their skepticism towards the new instrument of payment and transaction. Austin Carstens for example, manager of the Bank of International Settlements (BIS), called bitcoin “a combination of a bubble, a Ponzi scheme and an environmental disaster”. Considering the initial purpose of most private digital currencies which is to skirt traditional financial institutes, it is not quite a surprise that both private and central banks have not made a great effort to integrate such cryptocurrencies into their long-established community.
Just as strong as the skepticism for the bitcoin and other private digital currencies, is, on the other hand, the interest for the specific technology they operate on, known as blockchain. Powerful financial institutions all around the world are already considering the vast opportunities arising from applications of the blockchain technology. Through distributed ledgers it allows, for example, share and bond transactions to be performed directly between buyer and seller, saving a great amount of time and transaction costs. Scholars like Hans Kuhn, from the University of Luzern, see the potential in blockchain to introduce “the largest structural change since the abandonment of the gold standard in 1973”.
One of the first private banks in Europe to actively investigate the advantages of the blockchain technology are UBS and Deutsche Bank. Already in 2015, they started developing an own digital currency called the Utility Settlement Coin (USC). Soon, their project was joined by other major international banks like HSBC, Santander, and Barclays. Different from the bitcoin, the USC would guarantee a full transparency of any transactions. Backed by central bank money, it would also grant a greater value stability than existing private digital currencies which derive their value mostly from investors’ trust. According to Reuters, following further intensive talks with central banks and regulators, the USC could be launched in about two years from today. Its primary application, for the time being, would be as an instrument for transactions between banks on the so-called interbank market. However, Paul Maley, the Deutsche Bank manager in charge of the project sees a potential for a more general and public use of the new digital currency, for example through a ‘USC-Wallet’ he said to “Handelsblatt”.
Multiple National Central Banks, too, have recognized the potential benefits of state-backed digital currencies, also called central bank digital currencies (CBDCs). In fact, the cost of supply and maintenance of cash, which in most developed economies amounts around one to two percent of the countries’ GDP, could be drastically lowered. New perspectives would also arise for central bank’s monetary policy operations. For example, in case of a full replacement of cash by CBDC, central banks would have no problems setting interest rates below the zero level as means to boost the economy. Furthermore, seeing their role as monopoly issuers of currency threatened by the increasing popularity of private digital currencies like the bitcoin, some central banks have indeed already started developing their own forms of CBDC. In Sweden, where more than a third of the population never uses cash, the Riksbank will decide by the end the year whether to launch the “e-krona” as a complement to banknotes and coins. Such a measure would have the positive effect of reducing the exposure of the general public to private firms like credit card companies which continues to increase as the use of cash decreases. A majority of the developed economies, however, have seen an increase in the demand for cash money. In fact, according to BIS data, the average value of cash in circulation of 1.4% of Sweden’s GDP is rather exceptional considering values like 10.7% in the Euro area or 20% in Japan. Therefore a CBDC use according to the Swedish model will be hardly feasible in most other developed economies for the present. Nevertheless, the ECB, in cooperation with the Bank of Japan, is currently testing the possible utilization of CBDC in the financial markets infrastructure.
The most radical model of future CBDC use could be an account for each citizen at the respective central bank, turning it into a public bank while granting complete control and transparency over all transactions of its country’s citizens. While in western democracies such models could only be realized in a strongly alleviated form, it could be an attractive model for countries like China or Russia where the state’s control over the general public’s activities plays an important role.
The future prospects of state-backed cryptocurrencies were also outlined in detail in a report by the BIS published in mid-March. The BIS confirmed the potential of CBDCs to greatly increase the efficiency of tasks such as settling payments between financial institutions. According to the report, even an implementation of CBDC beyond the interbank market - in other words for public use - could revolutionize the way money is provided and fundamentally change the role of central banks in the financial system. On the other hand, the BIS also pointed to the stability risk that CBDC could pose on the global financial system if it were directly accessible by the public. In times of panic, so-called ‘digital runs’ from riskier assets and private financial institutions to the state would become very likely. Similarly, countries facing turmoil would fall victim to ‘cross-border panics’, as capital could shift into state-backed crypto-currencies elsewhere with uncontrollable speed. In conclusion, the BIS, therefore, encouraged National Central banks to continue the careful and thorough study of the opportunities of the distributed ledger technology before taking any steps towards the launch of publically accessible CBDC.
Benjamin Maglajac
Just as strong as the skepticism for the bitcoin and other private digital currencies, is, on the other hand, the interest for the specific technology they operate on, known as blockchain. Powerful financial institutions all around the world are already considering the vast opportunities arising from applications of the blockchain technology. Through distributed ledgers it allows, for example, share and bond transactions to be performed directly between buyer and seller, saving a great amount of time and transaction costs. Scholars like Hans Kuhn, from the University of Luzern, see the potential in blockchain to introduce “the largest structural change since the abandonment of the gold standard in 1973”.
One of the first private banks in Europe to actively investigate the advantages of the blockchain technology are UBS and Deutsche Bank. Already in 2015, they started developing an own digital currency called the Utility Settlement Coin (USC). Soon, their project was joined by other major international banks like HSBC, Santander, and Barclays. Different from the bitcoin, the USC would guarantee a full transparency of any transactions. Backed by central bank money, it would also grant a greater value stability than existing private digital currencies which derive their value mostly from investors’ trust. According to Reuters, following further intensive talks with central banks and regulators, the USC could be launched in about two years from today. Its primary application, for the time being, would be as an instrument for transactions between banks on the so-called interbank market. However, Paul Maley, the Deutsche Bank manager in charge of the project sees a potential for a more general and public use of the new digital currency, for example through a ‘USC-Wallet’ he said to “Handelsblatt”.
Multiple National Central Banks, too, have recognized the potential benefits of state-backed digital currencies, also called central bank digital currencies (CBDCs). In fact, the cost of supply and maintenance of cash, which in most developed economies amounts around one to two percent of the countries’ GDP, could be drastically lowered. New perspectives would also arise for central bank’s monetary policy operations. For example, in case of a full replacement of cash by CBDC, central banks would have no problems setting interest rates below the zero level as means to boost the economy. Furthermore, seeing their role as monopoly issuers of currency threatened by the increasing popularity of private digital currencies like the bitcoin, some central banks have indeed already started developing their own forms of CBDC. In Sweden, where more than a third of the population never uses cash, the Riksbank will decide by the end the year whether to launch the “e-krona” as a complement to banknotes and coins. Such a measure would have the positive effect of reducing the exposure of the general public to private firms like credit card companies which continues to increase as the use of cash decreases. A majority of the developed economies, however, have seen an increase in the demand for cash money. In fact, according to BIS data, the average value of cash in circulation of 1.4% of Sweden’s GDP is rather exceptional considering values like 10.7% in the Euro area or 20% in Japan. Therefore a CBDC use according to the Swedish model will be hardly feasible in most other developed economies for the present. Nevertheless, the ECB, in cooperation with the Bank of Japan, is currently testing the possible utilization of CBDC in the financial markets infrastructure.
The most radical model of future CBDC use could be an account for each citizen at the respective central bank, turning it into a public bank while granting complete control and transparency over all transactions of its country’s citizens. While in western democracies such models could only be realized in a strongly alleviated form, it could be an attractive model for countries like China or Russia where the state’s control over the general public’s activities plays an important role.
The future prospects of state-backed cryptocurrencies were also outlined in detail in a report by the BIS published in mid-March. The BIS confirmed the potential of CBDCs to greatly increase the efficiency of tasks such as settling payments between financial institutions. According to the report, even an implementation of CBDC beyond the interbank market - in other words for public use - could revolutionize the way money is provided and fundamentally change the role of central banks in the financial system. On the other hand, the BIS also pointed to the stability risk that CBDC could pose on the global financial system if it were directly accessible by the public. In times of panic, so-called ‘digital runs’ from riskier assets and private financial institutions to the state would become very likely. Similarly, countries facing turmoil would fall victim to ‘cross-border panics’, as capital could shift into state-backed crypto-currencies elsewhere with uncontrollable speed. In conclusion, the BIS, therefore, encouraged National Central banks to continue the careful and thorough study of the opportunities of the distributed ledger technology before taking any steps towards the launch of publically accessible CBDC.
Benjamin Maglajac