At the end of January, the World Economic Forum in Davos published a 28-page guide for central banks entitled “Central Bank Digital Currency CBDC Policy-Maker Toolkit“. The document is intended to help countries to introduce digital currencies. An insight from Demelza Hays.
The World Economic Forum’s Central Bank Digital Currency Policy-Maker Toolkit is a document that explains the design features of CBDC’s. Including potential benefits, risks and costs of implementation.
“CBDC Policy-Maker Toolkit” Design features
The message is clear: CBDC’s will not be harbingers of freedom and prosperity based on sound monetary principles. The most glaring arguments are the following:
- Firstly, CBDC’s from central banks are not intended to be public and legal crypto-currencies.
- Secondly, even if a central bank decides to issue a public and permission-free crypto-currency, regulators should allow its use only for small transactions similar to fiat cash.
- Third, the issuance of CBDC’s will not be controlled by an algorithm and will therefore be mathematically limited. Instead, the central bank will have full control over the CBDC.
- Fourth, if central banks decide to issue so-called “retail” CBDCs, they may have to increase their balance sheets (i.e. increase the existing money supply). Retail CBDC’s allow individuals and non-financial intermediaries to hold direct deposit accounts with the central bank, which in turn limits the ability of banks to increase the money supply via the money multiplier.
- Fifth, CBDC’s will be fiat currencies and therefore not convertible.
CBDC’s are neither public, meaning that anyone can view the transactions in the ledger, nor are they permission-free. Which means that anyone can write transactions to the ledger. The authors also point out that the CBDC will be able to veto the censorship of any transaction. Thus, the CBDC’s would allow central banks to monitor transactions even more closely than in the current two-tier central and commercial banking system, which includes anonymous physical cash and bearer shares.Free use of CBDC’s only for small amounts Regarding the second point, that a public and unlicensed CBDC should only be allowed for small transactions, the article provides further details. A universally accessible CBDC without identity requirements would increase the risk that the CBDC could be used for illegal activities and could also conflict with most know-your-customer (KYC) and anti-money laundering (AML) measures, as well as the fight against terrorist financing (CFT)”. This means that the “War on Cash” will become a “War on CBDC’s” for all CBDC’s that resemble the pseudonymous character of bitcoin. With regard to the third point – that the supply is not limited – the authors clearly state that “the central bank would fully control the issuance of CBDCs, as is the case with a centralised system“. Choice of counter-party risk is at the expense of commercial banks With regard to the fourth point, namely that central banks must increase the money supply preventively before they can issue a CBDC for retail customers, the authors point out that “the substitution of deposits by the CBDC could also have a dampening effect on the money multiplier process.” This means that if individuals have the choice of having a bank account with banks that pose counter-party risk, they may choose to have a bank account with the bank directly and then indirectly with the central bank, or a bank account directly with the central bank. One will probably choose the latter because there is one less counter-party. If individuals stop depositing money with commercial banks, how will banks use the money multiplier to create money out of thin air and “ensure a sufficient supply of liquidity to the economy”? Basically, this whole part of the article deals with the question of how a functioning economy could survive without a sustained deterioration in household savings. To the fifth point – that CBDC’s will be fiat and not convertible into real assets – the authors write:
“It is said that token-based CBDC’s at retail or wholesale are held by their owners in digital wallets of various kinds. Like physical cash, a “token” represents an object of stored value that is digital fiat money…” and “The public could have accounts of digitalised fiat currency at the central bank or hold CBDCs on mobile devices, prepaid cards or other forms of digital wallets. ”Therefore, CBDC’s will not be convertible into real assets like gold. The quantity and quality of the assets held by the central bank in its balance sheet, identical to the current system, will cause fluctuations in the exchange rate of the CBDC to other CBDCs. Traditional correspondent banks in international payment transactions Despite the clearly pro-government focus on the money supply, the authors make some good points. For example, the authors raise an important question regarding the CBDC’s for retail, namely why individuals are not allowed to have bank accounts with the central bank in the current monetary system. Currently, only certain banks, the so-called “correspondent banks”, have accounts with central banks. All other banks, so-called “correspondent banks”, have to cooperate with correspondent banks. Individuals are at the bottom of the food chain and pay transaction fees to a variety of intermediaries. Because of the digital nature of CBDCs, the authors argue that sending money abroad will have lower transaction costs, which result from the complex network of information and correspondent banks that currently handle foreign exchange transactions. However, the authors also pointed out earlier that the CBDCs are equivalent in wholesale terms to the current two-tier currency system. To reduce the complexity of the current system, the 28-page paper proposes to allow foreign entities to hold CBDCs directly. This is very interesting from a geopolitical point of view because any entrepreneurial central bank could create a convertible (not fiat) CBDC backed by real assets and then sell this CBDC to the world. This would trigger global competition among CBDCs with very low switching costs. Countries with CBDC’s based on sustainable and healthy money would immediately attract capital and the exchange rate would rise, and CBDC’s based on modern monetary theory would immediately lose capital. CBDC’s as direct liabilities of central banks Another interesting point that the authors emphasize is that CBDC’s are liabilities of the central bank. Central banks can issue CBDC’s as new liabilities by increasing their asset side with bonds or by taking over part of their existing liabilities, such as commercial bank reserves, and converting them into CBDC’s. Hopefully, central banks will do the latter to maintain the purchasing power of money in circulation. The authors of the CBDC Policy-Maker Toolkit successfully clarify the confusion of definitions and what a blockchain can and cannot do. They rightly point out that domestic wholesale central banks are the same as the two-tier banking system, where registered banks can store reserves with the central bank. These banks are then able to issue their own liabilities to bank depositors. The authors also explain that the much-vaunted advantage of immediate settlement is not a feature of distributed ledger technology, but rather a feature of conditional programming and general hash functions. The ability of securities platforms to reduce securities settlement from three days to immediate settlement is not a unique feature of blockchain databases. More competition in the currency market In conclusion, the authors write several times that the CBDC’s increase competition in the currency market. Although the authors mainly believe that the CBDC’s will compete in the retail market with commercial banks such as UBS and payment processors such as Worldline and SIX. In addition, the CBDC’s will also have to compete with crypto-currencies such as bitcoin, decentralized stablecoins such as MakerDao and privately issued funds such as Facebook’s Libra. The central banks face a very difficult decision as to whether to continue to appease political whims with cheap money or die out. In summary, CBDC,s are nothing more than the emperor’s new, albeit invisible, clothes.
“But he isn’t wearing anything!” cried the whole nation in the end. This gripped the Emperor, for the people seemed to agree with him, but he thought to himself: “Now I must endure. And the chamberlains went and carried the train, which was not there. – Hans Christian Andersen, 1837* Originally published in German at CVJ.ch
