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Central Bank Digital Currencies: The Next Step On Monetary Policy Development?

Published on: 10 June, 2019

Blockchain as a technology has a lot of different use-cases. Just to mention a few, we can use it as a way to store value (Bitcoin), as a way to deploy the code that controls organization (DAOs), as a crowdfunding method through crypto-assets (ICOs, STOs & Private Sales) or as a programmable framework to execute smart contracts that provide multiple use-cases on almost any industry you could think of.

Blockchain, just like the Internet, can be used on several verticals either by the public or private sector. With that being said, one question arises naturally: Would there be any benefits for central banks, users and commercial banks when using a central bank digital currency (CBDC)?

As we’ve analyzed on a previous article, governments could have many interesting reasons to explore blockchain technology:

1 – Digital currencies provide higher security for individuals. This aspect is radically important on remote regions or countries with high levels of insecurity.

2 – Billions of people all over the world don’t have access to financial and banking services. A digital currency acting as legal tender would enable governments to include millions of excluded citizens into the financial circuit.

3 – Private blockchains would enable governments to considerably reduce volatility. There would obviously exist a considerable associated cost in terms of decentralization but CBDCs in essence are not supposed to be direct competitors to decentralized options like Bitcoin but rather alternatives. Mitigating volatility could enable governments to get widespread usage of a blockchain-based legal tender among non-technical population.

4 – Digital currencies could eliminate or reduce intermediation costs. By using a centralized digital currency, there would be no need to use typical intermediaries. Citizens would probably be cutting down costs in many different ways.

So as we can see governments and central banks could have a lot of different reasons to explore blockchain technology. However, the other part of the equation, expressed by users and commercial banks, could have many valid reasons to stay reluctant to a monetary proposal based on CBDCs. Which could be the most probable reasons for this to occur?

As we have already covered with great detail here, the costs of privacy invasion & negative interest rates could become important deterrents for citizens. Additionally, private banks would have to drastically change their business model on several verticals and get used to further control from central banks (specially when it comes to the way they currently operate under the fractional reserve system). Even though central banks’ were not designed nor are expected to interact directly with citizens, many of the functions that commercial banks currently perform should probably evolve bringing new and different profitable options for their customers while at the same time increasing central banks´ control over the monetary aggregates.

Now, what’s the current status of CBDCs around the world? Are there any countries or republics that are already experimenting with CBDCs? Are central banks around the world and monetary organisms actually exploring CBDCs?

On November 2018, the IMF published a very interesting paper analyzing CBDCs and seems to be exploring with the World Bank a quasi-criptocurrency. Countries like Australia, Uruguay, England, Canada, Israel among others are exploring the possibilities of CBDCs and there are cases like SOV on the Republic of the Marshall Islands that are currently implemented. Based on these examples, there’s  obviously active research going on around this subject on several countries. On this context, one of the main questions would probably be the following: How could a CBDC actually become successful, universal and willingly accepted by the citizens of a country?

By providing better results when compared to other monetary options. On the legacy system, holders don´t have control over the inflation rate nor government-debt levels. On the other side, crypto-assets based on public and decentralized blockchain technology are usually criticized because of their volatility. If governments could find a way to capitalize on the benefits of blockchain technology while at the same time removing the traditional problems of the legacy system, they could have an interesting monetary option. However, this would require a government to stick into a fixed money supply model where issuance rate should remain unaltered over time. Time will tell if governments can indeed compromise to such restrictions on their monetary policies but one thing is definitely clear: there will always be users preferring decentralized digital assets. This will probably lead us into a future where legal tender under private blockchains will have to co-exist with decentralized options such as Bitcoin on an interoperable monetary framework.