Earlier this month, Benoit Coeure, a well-known central bank policymaker, sounded an alarm for central banks to act now on minting their own central bank digital currencies (CBDCs).
In a speech, the former European Central Bank economist who leads innovation at the Bank of International Settlements (BIS) warned that rapidly mushrooming cryptocurrencies will challenge the business models of international banking — if monetary authorities don’t quickly act.
As China moved on Friday to effectively outlaw cryptocurrency — which roiled digital coin spot prices worldwide — central banks around the world are redoubling their efforts to exert influence of their own within the sector. It underscores what most observers believe is shaping up to be an arms race in a new era of global finance.
The Bank of International Settlements/BIS's innovation hub recently announced plans to build a crypto platform so the international community of central bankers can transact in CBDCs and other crypto assets.
Calling the feat Project Dunbar, the effort begins with designing a supposedly decentralized platform so the dozens of countries whipping up their own style of CBDC can make use of the new technology the same way retail investors trade cryptocurrency and NFTs.
“The technology behind digital currency is quite elegant in that it cuts out a lot of the operational complexity associated with exchange, clearing and settlement of payments on the backend,” Andrew McCormack, Centre Head of the BIS Innovation Hub Singapore, told Yahoo Finance.
In partnership with central banks in Australia, Malaysia, Singapore and South Africa, Project Dunbar wants to build a platform for CBDCs to improve cross border transactions for the international banking community.
Twitter's integration of cryptocurrencies for tipping this week is a similar display of this use case for crypto. It's also a solution to the same problem that the government of El Salvador is trying to solve by making bitcoin legal tender.
Unlike, these other projects, the BIS isn't aiming just to make cross-border payments easier for regular people. To be successful, it also must solve the problem for massively large money exchanges between banks, governments and corporate entities.
'Borrowed from decentralized finance'
Photo taken on July 15, 2021 shows the U.S. Federal Reserve in Washington, D.C., the United States. U.S. Federal Reserve Chair Jerome Powell said on Thursday that he was "legitimately undecided" on the benefits and costs of issuing a U.S. central bank digital currency CBDC. "I think our obligation is to explore both the technology and the policy issues over the next couple of years. That's what we're going to do so that we're in a position to make an informed recommendation," Powell said during a hearing before the Senate Banking Committee when asked to clarify his position on the CBDC. (Photo by Liu Jie/Xinhua via Getty Images) ·(Xinhua News Agency via Getty Images)
Furthermore, a crypto platform for central banks needs to address another concern, one that derives from crypto.
Without an efficiently decentralized platform - meaning no single entity owns it - major commercial headaches will likely spring up once central banks across the world begin to sling their own CBDCs in the coming years. These tokens act as digital equivalents for government-backed fiat currencies like the euro (EURUSD), Chinese yuan (USDCNY), the U.S. dollar (USDX) and Malaysia's ringgit.
There are digital currencies that run off distributed ledger or blockchain technology-built protocols similar to cryptocurrencies such as Bitcoin (BTC-USD), Ethereum (ETH-USD) and Dogecoin (DOGE-USD). But as a form of money, the end goal for CBDCs are entirely different.
Unlike many cryptocurrencies that offer varying levels of decentralization, CBDCs give central banks enhanced power to coordinate and control a nation's cash and set monetary policy. Jean-Pierre Landau, a former deputy governor of the Banque de France, told The Economist in May that Facebook's (FB) digital currency plans — and the loss of control over money it represented — came as "a real shock for most of the international monetary community.”
Today, international banking moves the bulk of the world’s money through a complex, multi-layered account-based system. A single transaction requires message exchanges and clearing processes between different banking entities.
Ultimately, transactions are settled by a common entity, usually a central bank. The outcome is slow by today’s standard of settlements for tokenized assets: For instance, a payment settlement between parties in Asia and North America can take more than a day.
Beyond making cross border transactions faster, cheaper and more efficient, CBDCs offer monetary authorities a whole new range of tools for shaping policy as society moves toward cashless transactions. In an interview with The Wall Street Journal in early September, the BIS's Coeure said that central banks could use the technology to cut interest rates far below zero.
Interestingly, the BIS project is using platforms developed in the crypto sector such as the DeFi platform, Uniswap — which is reported to be under investigation by the Securities and Exchanges Commission — as one model to develop their own platform for CBDCs.
“We've borrowed from, from the decentralized, finance world, if you will. It goes back to Bitcoin. It's this notion of a decentralized network that has some level of programmability, and some level of security, and then obviously, deep cryptography to ensure the integrity of the assets that exist on the network," said McCormack.
A big step in central banking
CBDC Central Bank Digital Currency banner web icon for financial and digital payment, government, centralize, trust, money and blockchain. Minimal modern vector infographic. ·(https://www.facebook.com/PlargueDoctor/ via Getty Images)
More than 81 countries are exploring CBDCs according to The Atlantic Council, a Washington-based think tank, tracks the progress of various CBDC projects throughout the world. At least 5 Caribbean nations have already launched a digital currency, and 14 others are in the pilot phase with the central bank of Bhutan announcing most recently that they will partner with the cryptocurrency Ripple (XRP).
Well into their pilot phase, China's PBC plans making their CBDC, the digital yuan, available to foreign visitors during the upcoming Winter Olympics held in Beijing. It's unclear how Beijing's move to ban crypto will alter their plans in CBDC.
The level of coordination needed to build a "permissioned" platform for all these new CBDCs and other digital assets to interact will be daunting. The progress, policy aims and regulation around any one CBDC could vary drastically between central banks.
It's a “big step” said Gina Pieters, an economics professor at the University of Chicago — especially given the different barriers of access and regulation for wholesale and retail banking.
Pieters, who has published research on a range of cryptocurrency and blockchain technology subjects from as far back as 2014, told Yahoo Finance that "it will be interesting to see how these differ barriers translate” to the development of CBDCs.
With so many digital coins being created in the coming years, the BIS is equally concerned about updating their own technology layer behind central banking. But at this point its not clear whether improving the existing infrastructure matters as much as keeping some level of coordination and control between central banks so that countries minting digital currencies and platforms don't create major currency exchange problems for international banking
If every country issues its own CBDC on its own platform, and none of the systems can interact with each other, a major value from cryptocurrency - more efficient cross border payments - might be ignored according to Valar's McCormack. That’s why the BIS is taking inspiration from the design of decentralized finance platforms found in the crypto sector like Uniswap.
“If we have a common platform for CBDCs we can explore things like automated market making and foreign exchange conversion which are interesting and important concepts to us,” McCormack added.
A Uniswap-like construct made and owned by central banks is just one concept the BIS will test.
But the primary focus now is to build an Ethereum-like blockchain project that would provide a space where central bank money could be issued and accessed by a banking players from commercial banks to payment services, regulated wallet providers and potentially larger corporate players.
That differs from just hosting DeFi applications and mountains of other cryptocurrencies and (non-fungible tokens) NFTs.
To be sure, the permissioned nature of a CBDC platform could also create limitations that undercut their value as a currency.
Arguably, the openness behind cryptocurrencies like bitcoin and ethereum is one of the foundational principles behind why so many people expect them to hold and increase in future value as the internet for money.
“Something unique to the crypto-sector is the integration of transparent and public on-chain governance,” said University of Chicago's Pieters. “I don't know to what extent that can be adopted into a digital currency project like this, though.”
David Hollerith covers cryptocurrency for Yahoo Finance. Follow him @dshollers.
