While China is driving ahead with its digital yuan initiative, other major CBDC projects have been making steadier progress. Deutsche Bank’s Graham Buck reports.
Having won the opening battles, will private cryptocurrencies ultimately lose the war? Put another way, after surviving price volatility and efforts to limit their development, will cryptocurrencies ultimately be eclipsed by central bank digital currencies (CBDCs)?
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The attitude of the world’s central banks towards CBDCs has undergone a marked sea change. As the Bank for International Settlements (BIS) noted in an August 2020 working paper, US economist James Tobin outlined the concept in 1987 but early responses ranged from sceptical to hostile. Yet the BIS’s 2021 survey of more than 60 central banks found that 86% of them were developing a CBDC.
The work extends beyond research: 14% of them are already running pilot projects and 60% are experimenting with a proof-of-concept. Innate caution has given way to acceptance that a steady decline in the use of cash requires a response – preferably one involving a degree of government oversight.
The perceived benefits of CBDCs include reduced potential for fraud and other financial crime such as tax evasion and funding terrorism
The pandemic has accelerated the process, drawing consumers away from banknotes and cash and making them accustomed to contactless payments. Marion Laboure, a macro strategist and research analyst at Deutsche Bank, describes cash as “the dinosaur that has not died” and suggests that, while in no danger of any imminent demise, the pandemic has accelerated its decline by four or five years. “The world has shifted from asking whether digital currencies will succeed, to how and when they will become mainstream,” she wrote in a recent white paper. “Using cryptocurrencies for payments will accelerate.”
For governments, the perceived benefits of CBDCs include reduced potential for fraud and other financial crime such as tax evasion and funding terrorism; facilitating instant and cross-border payments; reduced transaction costs; greater financial inclusion within society; and the ability to target financial aid directly to individuals.
Introducing CBDCs in combination with distributed ledger technology (DLT) also offers governments and central banks various governance advantages, enabling them to exercise control over money transfers to companies and individuals, and devise more targeted, efficient monetary and fiscal policies.
Varying speeds
Although the era of the digital dollar, euro and pound is steadily approaching, actual CBDC launches to date have been on a small scale. The Bahamas was a pioneer, launching the so-called ‘sand dollar’ – a digital version of the Bahamian dollar – in October 2020. Sweden’s e-krona pilot is also making progress, with the Riksbank announcing in April that the coming months will see commercial banks included in the next stage of its project on how a CBDC would affect commercial and retail payments.
More significantly, the People’s Bank of China (PBOC) has been piloting a digital yuan since its April 2020 trial in four Chinese cities, and it aims to ramp up domestic use ahead of February 2022’s Winter Olympics. “The introduction of a digital currency in China could lead to an acceleration of other projects as other central bankers become more worried about the race for digital currency supremacy,” suggests Markus Mueller, managing director, global head of chief investment office at Deutsche Bank International Private Bank (IPB).
Many have commented that the Chinese government’s keenness to push ahead with the initiative is driven by more than the benefits outlined above. Adopting a CBDC for use both at home and internationally would see China challenge the dollar’s dominance. The size of its population and economy strongly positions China for superseding the US at some future point as the main provider of the global reserve currency, a major motivator for leading the CBDC race.
“At the same time, [other] central banks have not stood idly by,” says Mr Mueller. “The monopoly of money creation and management has traditionally lain in the hands of central banks – or monetary authorities – in most countries. Naturally, they are interested in keeping a control on what constitutes money to effectively manage the economy. “In that sense, accelerated central bank research and experimenting activity around CBDC can be interpreted as a reaction to the development and evolution of private cryptocurrencies and the various private payment providers. Central banks want to establish an alternative state-of-the-art payment solution.”
Ms Laboure agrees that central bankers and policy-makers in Europe and North America are likely to accelerate their research on CBDCs and launch pilots; she also expects them to displace non-bank digital currencies over time and become the norm. But progress is lagging compared to the PBOC’s rapid rate of development.
In October, the European Central Bank (ECB) announced it was stepping up its review of a digital euro and reported that feedback from a public consultation had been generally favourable, despite concerns over privacy issues. Confirmation is expected shortly on whether it will begin working towards a launch.
Recent guidance from ECB president Christine Lagarde indicates that, provided the bank’s policy-makers approve the project, the digital version could become reality by mid-decade. “We need to make sure that we do it right. We owe it to the Europeans,” said Ms Lagarde. “The whole process – let’s be realistic about it – will, in my view, take another four years, maybe a little more.”
Across the Atlantic, the Federal Reserve announced on May 20 that it will issue a research paper on a digital currency in the summer, with chairman Jerome Powell commenting that the Fed had been “carefully monitoring and adapting” to innovation in payments technology.
Previously his tone has been cautious. While the Fed has begun a major research and development project on a CBDC and is working with the Massachusetts Institute of Technology (MIT) to establish a technology platform for supporting a digital dollar, Mr Powell has regularly emphasised that the Fed feels under no pressure to be first. In a recent CBS interview, he maintained that the jury is still out on whether such a launch would actually provide a public benefit, and that any decision needs to involve both the public and Congress.
Meanwhile, the Digital Dollar Project – a non-profit joint initiative between the Digital Dollar Foundation and consultancy Accenture – will run five pilot programmes over the next 12 months whereby financial firms, retailers and non-governmental organisations will test the potential uses of a US CBDC. The aim is to complement the MIT project and generate data to help policy-makers in developing a digital dollar.
Competing with crypto
The Bank of England (BoE), which over several years has assessed the case for a digital pound, announced on April 19 that it was setting up a taskforce with HM Treasury to explore the potential for a sterling-denominated CBDC. Its remit will be to consider the “benefits, risks and practicalities”, and whether the use case for such a development is sufficiently strong.
A Reuters report noted: “A BoE-backed digital version of sterling would potentially allow businesses and consumers to hold accounts directly with the [central] bank and to sidestep others when making payments, upending the lenders’ role in the financial system.”
Money creation and management has traditionally lain in the hands of central banks – or monetary authorities
But with China leading the race towards a launch, and others still at various stages of development, whether CBDCs will ultimately diminish the appeal of bitcoin and its peers is unclear. Alexander Bechtel, head of DLT and digital asset strategy at Deutsche Bank Corporate Bank, describes bitcoin and CBDCs as “two totally different animals”, each with its distinct ideology and expectation of how the monetary system should work. Bitcoin, as a fully decentralised, permissionless, open and borderless system for storing and transferring value, lacks any central authority or monetary policy, as the maximum supply of bitcoins is fixed.
“That might sound attractive, but comes with several trade-offs: for example, it is difficult to square with existing regulation, there’s no institution you can go to or number to phone if you have problems, and it does not scale properly,” says Mr Bechtel. By contrast, a CBDC is digital legal tender issued by a central monetary authority. “It is fully controlled by the state and the central bank acts as the trusted third party conducting monetary policy by steering interest rates and changing the money supply.”
Nonetheless, non-bank digital currencies have significant attractions, which were examined in a Deutsche Bank IPB report, published shortly after the BoE’s announcement. In ‘A tale of two siblings: cryptocurrencies and CBDC’, Deutsche Bank IPB global chief investment officer Christian Nolting suggests that while CBDCs and private sector cryptocurrencies are “far from being two sides of the same coin”, both may now be approaching critical mass. The latter are here to stay, the report concludes, but in the longer term their appeal could wane once central banks in developed economies start rolling out CBDCs.
Mr Nolting adds that the potential policy and societal impact of a CBDC will be better assessed once one reaches full operation in a major economy, which could still be several years away. However, governments and more digitally aware populations could ultimately favour CBDCs over bitcoin and its peers. In that event, he says, “the more successful cryptocurrencies are likely to become increasingly differentiated in terms of business models and utility”.
Graham Buck is editor, cash management at Deutsche Bank Global Transaction Banking.
