On June 23, the Bank for International Settlements pre-released one chapter of its Annual Economic Report. The chapter extols the benefits of central bank digital currencies (CBDCs), attempting to articulate their promise in contradistinction to several key market trends that the BIS fears pose threats to international monetary stability. With this release, the BIS has presented what are sure to be the key policy arguments in favor of the global trend towards the formal establishment of national digital currencies issued by central banks. China is already well on its way to this goal, and the U.S. Federal Reserve, the European Central Bank and the Bank of England have similar pursuits under development.
At its core, and though it only briefly addresses the questions head on, the chapter is an apologetic for the benefits of a well-managed central bank digital currency system over the proliferating market of cryptocurrencies now in existence. The chapter lays out key policy and technical considerations for the design and structure of CBDC solutions (whether solitary, or united across geographies, a profound question we will leave for another day).
The chapter reviews the public interest and monetary justifications for CBDCs, debating the benefits of a one-tier and two-tier system. A one-tier system would involve the direct management by a central bank of the digital payments mechanisms; a two-tier system would be run through private sector intermediaries, much as the structure of the current cash system. It concludes that a two-tier system is preferable, hinting (though not stating outright) that the current intermediary structure is directly mappable to the digitization to come.
While the tiering proposal contains ample information for debate in and of itself, there are two key areas, likely to be the focus of intense disagreement in the months to come, where the BIS chapter fails to fully engage the reader. The first is the future trajectory of cryptocurrencies vis-à-vis CBDC solutions; the second is the complexity of managing and protecting the privacy and the personal data of individual users of CBDCs.
Whither cryptocurrencies?
Arguably the most fundamental question for modern monetary enthusiasts is the relationship between the multitudinous cryptocurrency assets extant, and the future national digital currencies that have the potential to occupy the digital payments field. On that point, the BIS only directly musters two brief, telling sentences, “By now, it is clear that cryptocurrencies are speculative assets rather than money, and in many cases are used to facilitate money laundering, ransomware attacks and other financial crimes. Bitcoin in particular has few redeeming public interest attributes when also considering its wasteful energy footprint.”
Stablecoins are also not exempt from the scorn of the BIS, being described as an “attempt to import credibility by being backed by real currencies” and as such “are only as good as the governance behind the promise of the backing.” As a result, the BIS concludes that they are “ultimately only an appendage to the conventional monetary system and not a game changer.” This statement may raise eyebrows within some national regulators that have publicly talked about stablecoins being the most likely form of crytpoasset to see mass adoption.
The message to would-be regulators from the BIS seems clear. In its opinion, cryptoassets in the form of exchange tokens (and to some extent, also stablecoins) serve no purpose and (alluded to in other ways elsewhere the paper) threaten monetary stability. One can only conclude the BIS’s position is that such assets must be regulated away, regulated into something more manageable or, at the very least, prevented from being capable of the sort of mass adoption that would give rise to financial stability concerns.
Notwithstanding the force of this opinion and potential evidence regarding the volume of criminality aside, the failure to address the future friction is likely to leave readers of this chapter wanting more of an explanation about why such a significant component of decentralized finance seems so easily dismissed. To be certain, policy makers will have to grapple with these colliding worlds, and one looks forward to the rich public dialogue that must be pursued.
Privacy paradox?
Also notable in the chapter is the BIS’s laudable struggle to harmonize certain public interest goals with the privacy concerns that the BIS recognizes as valid. It would be unfair to expect the BIS to resolve this complex conundrum in a chapter. Yet, the technical ironies embedded in their proposed solutions will, similar to the crypto dismissal, offer grounds for substantial public debate.
For reasons beyond the scope of this blog, the BIS forcefully concludes that CBDCs must be account-based and ultimately tied to a digital identity. The BIS rejects a token-based CBDC that would enable pseudo-anonymity. In other words, the BIS concludes that interested parties must be able to fully identify participants in the CBDC exchange system. The paper recognizes the privacy threats involved in centralizing visibility into an individual’s digital monetary footprint, and performs a brief survey of options for managing this challenge. The BIS pays service to the need for privacy controls and praises a “federated digital ID” model where “an individual’s personal identity is stored in several distinct identity systems, while allowing for interoperability and authentication across systems and external applications.” But, the paper says little about the actual way such a federated system would successfully maintain privacy or limit visibility into individual activities that are presumably central concerns for those worried about government access to identity information.
The BIS paper constitutes a praiseworthy consolidation of numerous key issues surrounding CBDCs. Yet, in projecting objectivity, it would do well to further grapple with core concerns that, even if not central to the BIS’s ideal vision, certainly will be to the market’s adoption of it.
