With the news agenda dominated by Covid-19, progress that the banking elite are making on plans to introduce central bank digital currency is gaining scant attention. My last article – ‘CBDC’s: The Overarching Goal Behind the Digitisation of Money?‘ – gave a brief overview of some of the latest developments emanating from the Bank for International Settlements. Since then members of the BIS – which include every major central bank in the world – have started to share extensive detail on their own CBDC objectives.
On March 12th, just eleven days before the UK was forced into a crippling economic lockdown, the Bank of England published a 57 page discussion paper titled, ‘Central Bank Digital Currency – Opportunities, challenges and design‘. For the first time they brought out into the open how a CBDC issued by the bank could be fashioned and implemented.
Before delving into the paper, a distinction needs to be drawn between a central bank issued digital currency and the digitisation of the money in your bank account. As the BOE correctly observes, the two are not to be confused for the same thing. The only central bank money an individual can hold at present are banknotes, which means that the money sitting in your account now is commercial bank money. Whilst we have the right to convert that money back into banknotes (central bank money), the BOE reminds us that ‘a customer needing to make a payment relies on their bank to have sufficient assets to enable a cash withdrawal or enable settlement with another bank‘.
So if the bank has insufficient assets on its balance sheet at the time a request is made for funds, you will not be able to access your money. The reason for this is simple, and one that the BOE is forthright over: bank deposits are only created when banks issue loans. What this really means is that the money in your bank account belongs to the bank. You have the right to make a claim on the money but only if the bank can honour the request. The stark realisation then is that the only time money truly belongs to you is when you physically have it in your hand.
But with the advent of the coronavirus pandemic, the public’s desire to hold cash has declined markedly. This comes as the call for banknotes had already been falling year on year. The BOE’s position is that whilst there remains a demand for cash, ‘the bank is committed to meeting this demand‘. But should the downward trend continue, the dynamic will shift further towards commercial bank money and away from the banknotes issued by the central bank.
The ‘solution‘ that the Bank of England and their brethren have been working on for a number of years is the introduction of CBDC’s. We are led to believe by the BOE that should they issue a CBDC in the future, it would ‘likely act as a complement to cash rather than a substitute‘. But as I have pointed out on numerous occasions, the general manager of the BIS, Agustin Carstens, thinks differently. According to him, in a CBDC world, all payments would be electronic. ‘He or she would no longer have the option of paying cash‘.
Beyond doubt is that a shift away from cash to a CBDC – which the discussion paper describes as a ‘new form of money‘ and a ‘new payments infrastructure‘ – would embolden the BOE in that a digital variant of banknotes would ‘increase the availability and usability of central bank money‘. From my perspective that is what the push towards CBDC’s is partly about. They would be a vehicle for both maintaining and increasing the power base of central banks.
If there is one thing the banking elite are not is sentimental. I believe they would readily endorse the gradual withdraw of cash if it meant a CBDC allowed them to capture the majority of the population in terms of tracking their spending and controlling their access to funds. With banknotes the BOE have no direct way of knowing how or where you are using your cash. It affords a level of anonymity that a CBDC would not offer.
The BOE confirm this by stating that ‘neither an account‑based CBDC or a token-based approach would enable cash‑like transfers, where a payment can be made without reference to any third party or intermediary‘.
The BOE also mention in the paper that a CBDC ‘could be designed in a way that protects users’ privacy to a greater extent than some existing payment systems, subject to being fully compliant with all relevant regulations, particularly anti‑money laundering requirements‘. In essence, this means that any level of privacy over CBDC usage would be subject to regulation, meaning complete anonymity is out of the question.
The advantages for the BOE of sacrificing cash in favour of a CBDC are there to see. But what would this mean for the traditional process of bank deposits? According to the bank, ‘the introduction of CBDC will lead to some substitution away from existing forms of money‘. The move away from cash is one thing. But a shift away from commercial bank money is very different.
The BOE inform us that a CBDC, like cash, would have no credit risk attached to it. This is not the case with bank deposits, which in the UK are only insured up to £85,000.
A possible scenario that the BOE paint is that if a CBDC was implemented, a proportion of households and businesses that hold commercial bank money may decide to exchange this for CBDC, given there are no credit risks. If that happened the commercial banks would ‘lose both deposits and assets in equal amounts‘, and in turn be left with a much reduced balance sheet. The BOE admit that this ‘could affect the availability of credit‘ and cause wider financial instability, to the point where ‘a period of rapid substitution from deposits to CBDC would be the equivalent to a run on the banking system.’
Right now, because of the BOE’s quantitative easing programme that began in the aftermath of Lehman Brothers’ collapse, cash reserves at commercial banks are ‘currently ample‘. Although the BOE do caution that this ‘may not always be the case‘.
The majority of the money used within Britain today is commercial bank money, which is unavoidable with cash usage in perpetual decline. But would customers want to transfer their deposits to a new CBDC account? Would there be benefits and enticements for doing so?
This leads to a hypothetical CBDC model that the discussion paper positions as the most palatable. As raised in my last article, a hybrid CBDC promoted by the BIS in which central banks enter into partnership with the private sector is the preferred choice. Unsurprisingly, the BOE – being an appendage of the central banking system – concur with this stance. To meet with the bank’s ‘design principles‘, private sector involvement is deemed essential.
What we would be looking at is a public-private payment platform where the BOE ‘would build a fast, highly secure and resilient technology platform‘ known as the core ledger. The bank’s ledger would ‘provide minimum necessary functionality for CBDC payments‘, all of which would be settled immediately. At the moment, payments made through debit cards can take several days to clear.
The core ledger would act as a platform for private sector firms, otherwise referred to as ‘Payment Interface Providers‘. These providers could connect to the ledger and thereby offer ‘customer-facing CBDC payment services‘. This is very similar to the model that former IMF managing director Christine Lagarde spoke about at the Singapore Fintech Festival in 2018. It is CBDC services that the BOE say firms could put together in conjunction with CBDC accounts, something which could tempt deposit holders to move capital out of commercial banks.
‘Payment Interface Providers‘ are essentially another term for services like Paypal and Google Pay. But in the model the BOE are focusing on, it could just as easily include commercial banks.
To access CBDC, customers would need to register with a provider. However, this would come with certain conditions. The identity of users would need to be authenticated, both to open an account and to make payments, in the name of protecting them against fraud and stamping out money laundering. Rights to anonymity would have to be waived.
As for how CBDC payments would be processed, the BOE mention that transactions between users of the same provider could go through their own systems and would not need to be ratified by the bank’s core ledger. But CBDC payments between two different providers – say Barclays and Santander – would need to go through the ledger, and by extension the BOE.
Connected to ‘Payment Interface Providers‘ is something called the ‘Application Programming Interface‘ (API). It is this that would permit private sector providers to connect to the BOE’s core ledger. Any unauthorised access would be automatically blocked, as only regulated firms would be granted entry.
Important to appreciate at this point is the ongoing work by the BOE to reform the Real Time Gross Settlement (RTGS) payment system, which is operated by the bank. The BOE summarise RTGS as ‘the infrastructure that holds accounts for banks, building societies and other institutions. The balances in these accounts can be used to move money in real time between these account holders, this delivers final and risk-free settlement.’
The bank are already communicating that their work on a CBDC will help them to ‘understand whether CBDC could interact with RTGS renewal‘. Why is this relevant? For one thing, the BOE believes that the core ledger ‘could build on our ambitious renewal of the RTGS service and complement private sector initiatives to improve payments‘.
Recall that the core ledger – the technology platform of a CBDC – would provide the ‘minimum necessary functionality‘. It would pave the way for the innovation behind a CBDC to take place within the private sector.
The BOE have not given a specific time frame for implementing a CBDC, but a potentially important year to keep in mind is 2023 which the bank are targeting for the transition to a new core ledger as part of the reform to the RTGS system. Might the renewal of RTGS be a prerequisite for introducing a CBDC? Based on the discussion paper it would appear that way.
In part two we will look at the some of the wider aspects to a CBDC issued by the Bank of England, including possible limitations of use and the deception around decentralisation.