EXCLUSIVE: “The CBDC Conundrum” – Hussein Jundi, ProgressSoft and Jeff Stewart in ‘The Fintech Magazine’
Are central bank digital currencies a solution in search of a problem, or a race for the future of money? ProgressSoft’s Hussein Jundi and payment consultant Jeff Stewart, explore the pros and cons
According to the technology’s advocates, the adoption of central bank digital currencies (CBDCs) will spur the biggest shift in monetary policy since the dollar was finally unhitched from the gold standard in 1971.
Students of the Bretton Woods system will know it was necessity that forced President Nixon’s hand then – with a rush on gold looming. The question for CBDC proponents is: why make radical changes to a system that’s not (yet) on the brink? Aren’t CBDCs a solution searching for a problem?
Before we get to that, it’s worth clearing up what a CBDC is – and what it isn’t. The idea is fairly simple: a CBDC is a country’s fiat currency in digital form, created, issued and regulated by that country’s central bank. For those piecing together ‘digital’ and ‘currency’ and arriving at the chilling conclusion that central banks may one day launch their own cryptocurrencies, Hussein Jundi, CBDC account manager at ProgressSoft puts them straight.
“A CBDC is designed to mimic cash in every way and form possible, only that it is in digital form,” he explains. “So, it has to comply with the defining rules of money: being a stable unit of account, a costless medium of exchange, and a secure store of value. Just like cash, it’s issued by the central bank, and therefore it should maintain a one-to-one exchange rate with the national currency. So that’s different, of course, from cryptocurrencies such as Bitcoin and Ethereum. CBDCs don’t have price volatility and don’t consume huge amounts of power like cryptocurrencies do, but they’re still built on the same technology – the blockchain and distributed ledger technology that cryptocurrencies use.”
Sounds reasonable – exciting, even – so what’s not to like about CBDCs, given that, among two of the most notable advantages, they’ll make cross-border transactions cheaper and easier for all of us and reduce the ridiculously high cost to banks of moving hard cash around? Well, libertarians believe that CBDCs could grant state-linked institutions a level of access to our spending data, citing China’s ‘social credit’ system as a warning.
Based on a private node, rather than Bitcoin’s public node, a CBDC may well be used by economists to sharpen their policymaking tools, but it could equally be used to promote a surveillance state. Members of the UK parliament’s upper house aren’t sold on the idea of CBDCs, either. Earlier this year, the House of Lords’ Economic Affairs Committee produced a report in which members cautioned that if a CBDC was introduced in the UK, people would be free to convert their bank deposits to the new currency – leaving commercial banks exposed to potentially existential credit and liquidity issues. In short, the very financial instability that prompted Nixon to abolish the convertibility of the dollar to gold in 1971 could actually be caused by the introduction of CBDCs.
Nonetheless, dozens of countries are pressing on with CBDC research, consultation and pilot studies. According to the Atlantic Council, 87 central banks are currently exploring digital-form fiat, together representing more than 90 per cent of global GDP. While China is the only major economy to have so far adopted a CBDC (e-CNY), the Central Bank of the Bahamas launched a CBDC (the Sand Dollar) in 2019, the Eastern Caribbean Central Bank, which presides over seven island nations, issued DCash, and the Central Bank of Nigeria has the e-Naira.
So, there must be significant benefits to CBDC adoption for central banks to be willing to bear the risks. Jeff Stewart, formerly of the Bank of Canada and now a leading payments systems consultant, says CBDCs weren’t killed in the crib by central bank policymakers because they hold out the promise of addressing specific strategic issues that regional monetary systems based on fiat currencies have simply failed to do.
“There are different policy drivers inciting central banks to explore CBDCs,” explains Stewart. “In western central banks, there’s a lot of conversation around maintaining control of monetary sovereignty, recognising the risk of instability coming, potentially, from cryptocurrencies. Even other CBDCs, from other central banks, could interrupt monetary sovereignty – so that’s a driver.
“But use cases differ around the world. For instance, Caribbean central bank digital currencies address the logistics of cash distribution across an island archipelago – that’s a major policy driver. In China and Nigeria, there’s the issue of other alternative e-money issuers, and closed-loop payment schemes arising, like WeChat Pay and Alipay in China. In some other jurisdictions, it’s the monitoring of transactions, or black-market activities and corruption that are major policy drivers.”
This explains why CBDC pilots are running in countries with radically different domestic policy agendas: Jamaica and Malaysia are currently piloting CBDCs, but so are Sweden and Singapore. For some, CBDCs represent a ‘greenfield payment system’, the chance for a reset. For countries located on the fringes of today’s global financial system, they could be seen as a golden ticket to greater inclusion in the financial system of tomorrow. Smaller economies, who’ve led the introduction of CBDCs, certainly enjoy greater freedom to ‘move fast and break things’ than their established counterparts.
For a country like the UK, an easily accessible, central bank-backed ‘Britcoin’ could address lingering financial inclusion concerns, especially in areas that are seeing local bank branches boarded up and ATMs withdrawn, restricting access to fiat money. And on the macro level, explains Jundi, a digital pound could have economy-wide benefits.
“CBDC payments don’t have to go through clearing or settlement solutions, since they’re utilising blockchain technology. So the transfer of value is instant, and the cost of handling cash – for commercial banks and the financial institutions – is much lower, too. On a higher level, that means that the money circulation in the country will actually be much faster, and this will even, ultimately, impact the GDP of the country.”
In April 2021, the Bank of England and the Treasury announced the creation of a CBDC Taskforce, catching the scent of these wide-ranging benefits. Sensibly, the Taskforce will first be consulting with financial institutions and technology providers to get a sense of whether a CBDC is feasible. They might get a less-than-enthusiastic response from some quarters, though, as Stewart explains.
“The problem is, existing payments systems and payments technologies aren’t standing still either; there’s a lot of dynamic movement happening in those spaces,” he says. “We see the SWIFT system updating to an ISO 20022, rich data standard that’s going to support a lot of opportunities for straight-through processing and innovation. At the retail level, there are real-time payment systems emerging, improving, updating all around the world. The credit card space is also incredibly dynamic. And then there’s the rise of closed-loop systems.”
Whether CBDCs find their yellow brick road will depend on how central banks engage with other industry players, and whether those players see value in a digital fiat that they’re not already extracting from today’s payments innovation. There is one clear benefit to CBDC adoption. Cryptocurrency advocates – notably, Ripple – have long touted the blockchain’s superiority over systems such as SWIFT in facilitating real-time, cross-border payments at virtually no cost.
CBDCs are based on the same technology and a joint report from Oliver Wyman and JPMorgan found that global CBDC adoption could save global corporates nearly $100billion annually. Widespread CBDC adoption would also help the international banking system outflank speculative cryptocurrencies, as well as stablecoins – which are issued by private companies, but with their value tied to a specific currency (Facebook’s apparently now doomed Libra/Diem project, attempted to tie it to several currencies, in fact). In doing so, a global network of CBDCs could definitively address fears in some sectors that unregulated cryptocurrencies are destined to destabilise global finance.
That would rely on central banks building multi-CBDC (mCBDC) systems.
A partnership between Australia, South Africa, Singapore and Malaysia, named Project Dunbar, is currently testing how that might work. Earlier this year, researchers at the Global Currency Initiative even proposed that central banks issue a joint, decentralised CBDC rather than finding ways for sovereign CBDCs to plug in to one another.
“Central banks also have to look at the future,” Jundi says. “They have to have proper interoperability to make cross-border payments work, and it’s very important for the central banks to be communicating with each other on a regional or even international level.”
Stewart agrees. “Central banks are considering their domestic policy drivers, but there’s a longer-term view of how to interconnect all of this in the international space. They’re looking at the little plugs and sockets – various kinds of bridging technologies – that you have to install right now to enable cross-border CBDC payments as a possibility in the future.”
As he says, payments are ‘a moving train, with a million moving parts’ and if the train isn‘t going to stop for CBDCs to join it, someone’s going to have to figure out the technology to allow them to jump on board. Happily, that’s the purpose for which fintechs were born. It’s going to be an interesting ride.