When Facebook announced its plans to launch a digital currency back in 2019, central banks were spooked. A new, private currency from an organisation with the reach and influence of Facebook could fundamentally disrupt their grip on the supply and control of money within their economies, and many have been motivated to pursue their own rival currencies in response. Since then, the pandemic and the accompanying boom in cryptocurrencies has accelerated these central bank digital currency (CBDCs) projects.
The idea of central banks issuing digital currencies has been discussed since the creation of pioneering cryptocurrency bitcoin in 2010. But it was Facebook’s announcement of Libra (renamed to Diem in December 2020) nine years later that spurred central banks into action, says Rémi Bourgeot, economist and associate fellow at the French Institute for International and Strategic Affairs (IRIS). “Central banks were planning to take their time and suddenly they were shocked by Facebook’s announcement.”
This has been exacerbated by the continued growth of bitcoin and other cryptocurrencies during the pandemic. “They’re really concerned about this craze, this huge bubble around bitcoin and all those cryptos – if money is more privatised, then central banks are at risk of losing that control over monetary policy and the business cycle.”
A recent survey by the Bank for International Settlements found that the share of central banks actively pursuing a digital currency project has grown by one-third over the past four years, now standing at 86%. Sweden’s Riksbank and the People’s Bank of China (PBOC) are leading the charge, vying to be the first to issue a fully fledged retail CBDC within the next year.
While there is little consensus on how precisely CBDCs should work, their viability has also been spurred by advances in the underlying technology. Distributed ledger technology (DLT) is now capable of undertaking simultaneous transactions rapidly, something that private digital currencies such as bitcoin have long struggled with.
This is transformative because many central banks want to build features like anonymity into their digital currencies, which relies on using this decentralised tech, says James Pomeroy, global economist at HSBC.
“Using distributed ledger technology gives you more flexibility in terms of the other decisions you can make; if you didn’t use that infrastructure and went down a more traditional payments infrastructure route, it really limits what you can do,” he says. “These big improvements in blockchain technology are really encouraging for central banks as they make that a much more viable option.”
One of the biggest draws of a central-bank-issued digital currency is that it would effectively eliminate transaction costs by removing the need for digital payments processors. This would free up resources for more productive investment: streamlining payments could unlock between 0.5% and 0.9% of GDP, according to estimates from the Kansas Fed.
A CBDC would help to connect these groups financially and digitally, unlocking a large, previously untapped consumer base. As economies look to a digital-led recovery from the pandemic, financial inclusion will an important determinant of strong and equitable economic growth, says Pomeroy.
“If you can use a central bank digital currency as a means to provide every single person in your country with access to a digital bank, that can have transformative implications in terms of payments, access to credit [and] economic growth,” he says. “Also, in terms of getting money to people in their pocket if you ever want to do economic stimulus.”
There are still bumps in the road for CBDC projects before these benefits can be tapped, however. By far the most requested feature of a CBDC, according to the European Central Bank’s (ECB) digital euro study, is privacy. But the nascence of CBDCs mean that most central banks do not have sufficient provisions to protect digital privacy yet, says IRIS’s Bourgeot.
“The architecture clearly isn’t in place right now,” he says. “It’s not obvious how to deal with privacy and the most sensible approach is to associate the central bank digital currency account with each individual, but that raises issues with privacy as any payment would become transparent and traceable.”
More alarmingly, CBDCs could also weaken the stability of banking systems, threaten to break the banking system as we know it today, potentially precipitating huge runs on commercial banks in times of crisis and draining them of the funds that they require to provide credit to the economy.
This threat of a CBDC-induced banking revolution is why most central banks are still taking a cautious tack, despite the urgency injected by Covid-19 and the crypto boom. As Federal Reserve chair Jerome Powell told the audience at an IMF panel discussion on CBDCs: “It’s more important to get it right than to be first.”