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Central Bank Digital Currencies (CBDCs) - The bane of the cryptocurrency industry

Central Bank Digital Currency – What’s going on?


In a quest to decentralize the globe, entrepreneurs have worked tirelessly to create a new status quo for world. Money, and the functions money serve, have been the main target of innovation. In the half decade past, the industry has blossomed tremendously, with projects like Ethereum, R3’s Corda, Hyperledger and more, becoming platforms for a new generation of high tech solutions facilitated by Blockchain and cryptography.


These innovations, although initially supported by small teams working on relatively fringe projects, has now reached highs that seems impossible a few years back. Market behemoths, like JP Morgan Chase, Facebook, Walmart, and more, have all become involved in the space with their own blockchain projects.


Although Stable Report focusing on stablecoins, and we see the introduction of large corporates as validation of the potential of this market, we recognize that private corporation are not the only players entering the space. Central Banks and their Digital Currency projects are very real, and will enter the market sooner rather than later.


The introduction on Facebook’s Libra (read Stable Report’s article on Libra here) has been a wake-up call for Central Banks around the world. The People’s Bank of China has been leading the way, and the industry media are buzzing with updates on their upcoming plans. But what are Central Bank Digital Currencies (CBDCs), and how do they function? Who are the key players in the market, which Central Banks will act first, and what is the expected timeline of CBDCs?


Is Bitcoin dead again?


Types and Functions of CBDCs


Through a Bank of International Settlements’(BIS) paper on Central Bank Digital Currency, a breakdown of money types was presented. The “Money Tree”, a Venn-like diagram the divided money characteristics into four separate categories, is presented below. These characteristics are a) digital, b) central bank issued, c) token/value-based, and d) widely accessible.



The Money Tree, which should be familiar to researchers of CBDCs, is a good tool for differentiating cryptocurrencies, traditional bank deposits and CBDCs from each other. In this diagram, three separate CBDC categories emerge: a) Central bank, account-based CBDCs, b) Token-based CBDCs for commercial banks, and c) Token-based CBDCs for general use.


The differences between the two token-based models is slight but important, since the proposed use of the two models focuses on different users. The commercial bank token model is focused on maintaining the Bank’s reserve targets and alleviating the settlement delays between the central bank and commercial banks. This solves pain points like overnight loans, cross-back payments, and more. The general purpose token-based CBDC model, however, would expand these uses to everyday transactions within the market – something like a central bank-sponsored Venmo, PayPal or CashApp using CBDC tokens.


The benefit of this model would be the continuation of existing banking practices with little deviation from today’s banking state of affairs. The third option, Account-based CBDCs, however, would expand the functions of central banks in way not seen in the past. This CBDC model would allow citizens and CBDC users to hold their funds in central bank-based accounts, potentially cutting into the market share of commercial banks. As presented in the BIS survey on CBDCs, the potential for users to shift funds from commercial bank accounts and into CBDC accounts can be quite high in certain occasions.


There are a lot of other factors a Central Bank needs to be mindful of before issuing a CBDC, but in many ways, selecting which of the above models a central bank will develop is the most important determinant to how significant a CBDC will be to the banking sector and the future of monetary policy.


Key Projects and Players in CBDCs:


So which Central Banks are exploring CBDCs, and how close are they to being officially issued?


As mentioned above, the interest towards CBDCs skyrocketed when the People’s Bank of China announced that it is expediting the launch of their own project; a decision which in turn was fueled by Facebook’s Libra stablecoin. Media coverage seems to suggest that the CBDC will be launching in late 2019, namely around November, and specifically before the launch of Libra in 2020.


Official designs for The People’s Bank of China’s CBDC are still not public, but reports dictate that it will be a two-tier system, with tokens being issued to banks and large telecommunication companies directly from the central bank, and through a private blockchain. The second tier system, from banks and telecom business to users, is still no known, although the PBoC aims for a transaction rate of around 300.000 per second. A more in depth analysis can be found in Binance Research’s dedicated segment on the topic.

Although PBoC’s CBDC is the world’s leading CBDC project, with research starting all the way back in 2014, you will find, unsurprisingly, multiple other banks extensively researching CBDCs. In the aforementioned BIS survey indicates that out of the 63 central banks which partook into their research, a whopping 70% (or 44 central banks) are currently, or soon to be, engaged in serious CBDC research.


In fact, the first consumer-based pilot CBDC program was launched by the Bank of Uruguay in late 2017. The program, otherwise known as the e-Peso, was an effort to increase financial inclusion in the country, and 20m e-Pesos were minted and distributed to businesses and individuals. The fund transfers were instant and peer-to-peer, either through text messages or through a dedicated e-Peso mobile app. The pilot was a success and was concluded in April of 2018. No further trials or plans are public as of yet.


An additional CBDC pilot project is underway in Sweden, however no official date is set as of yet. With the ever falling use of cash throughout Sweden, Sveriges Riksbank is exploring a e-Krona CBDC as a digital cash alternative. For Sveriges Riksbank, the rise of private payment providers, namely Swish - and app that has achieved near 60% market penetration by 2018 – brings with it unwanted third party risk, and the e-Krona could be a more secure solution as money enters the digital age.


However, the number of projects being researched and tested are plentiful and quite diverse. Accenture’s Global Blockchain Technology division has been particularly invested in CBDC research and implementation. Their reports (R)evolution of Money and (R)evolution of Money II do a great job exploring the technical setup and social need for smart CBDC development by central banks.


(R)evolution of Money II lists a myriad of projects Accenture has been a part of. Often times in partnership with R3, Accenture has been instrumental in leading Project Jasper, Project Jasper-Ubin, Project Stella and more, paving the way for CBDC experimentation and proving that the technology is mature enough to handle the volumes of transactions expected by CBDCs. This report mentions the exploratory work on CBDCs by the Bank of England, the Bank of Canada, the European Central Bank, the Riksbank, the Bank of Japan, the Monetary Authority of Singapore, and the Eastern Caribbean Central Bank; and is highly recommended reading for anyone that wants to learn more about CBDCs.


This piece would be amiss if it didn’t mention the work being conducted by the Bank of Russia, the Bank of Iran, and Venezuela’s Petro. Although the aforementioned projects are under development, little is known about the structure of Iran’s and Russia’s CBDCs, except that both have been touted as responses to US-imposed financial sanctions. Venezuela’s Petro, although state-sponsored, has more characteristics similar to a traditional asset-backed stable cryptocurrency than a CBDC, and has been highly controversial and mistrusted.


On a final note, CBDC exploration does not end there, with multiple other Central Banks reviewing the technology and gradually moving forward with it. The Hackernoon article “CBCD: 19 Countries Creating or Researching the Issuance of a Digital Decentralized Currency” is a good resource for anyone seeking to explore country-specific projects.


Expected Timeline of CBDC Launch:


The expected timeline for globe-wide CBDC development is yet unknown, but the space in heating up. China, which is leading the way, is expected to launch before 2020, but the timeline for CBDC issuance by western central banks still seems far away.

In IBM’s Think 2019 conference, the topic of CBDCs was discussed. Michael Warner, strategist for the San Francisco Fed, argued that a FedCoin is still at least a decade way, and that the Fed will be the last institution to explore CBDCs since the US Dollar is already leading the traditional global financial market.


In the Europe front, the ECB has mentioned that Wholesale CBDCs are a viable option for the future. In most cases, wholesale CBDCs between commercial banks and central banks seem to be the technology that central banks are most excited to explore. All signs show that these will lead the way.


Therefore, it seems safe to say that the 2020s might be the decade of financial innovation on money, cryptocurrencies, stablecoins and CBDCs. Everything seems to align with this trajectory, and money is due to change forever. Get ready.


Conclusions and Other Thoughts


So, where do we stand? CBDCs seem to be becoming a reality sooner rather than later; at least in the East and in emerging markets. What is holding their development back, and are CBDCs a threat to cryptocurrencies? What about stablecoins? The answers are not yet known, but with the information available, let’s try to speculate.


For most cases, CBDCs will start through wholesale, with Central Banks issuing token to commercial banks long before you, the end user, gets a hold of them. Why is that? Well, mostly because the technology can help elevate pain points in the settlement process between banks and central banks.


Will general purpose, token-based CBDCs enter the retail market? Yes, but probably after wholesale CBDCs become the norm in the back-end of intra-bank and cross-bank transaction. Commercial bank account (or an alternative) will be needed to access these CBDCs when they come.


What about the third option? CBDC accounts in the Central Banks for general purposes? The future for such project is unknown, but it seems to bring an unnecessary risk with their implementation. It will be a financial innovation that commercial banks won’t be ready for, since Central Bank accounts will inherently be less risky; and of course less profitable, with no interest returns offered to account holders.


But will a meager interest rate counter the uncertainty of keeping your money in commercial bank accounts? Not in times of economic downturn, nor when interest rates are in near historic lows, like today. In most cases, account-based CBDCs will interfere with fractional reserve banking, and I expect them to be the last CBDC version to be explored, and only in countries where financial uncertainty is at its peak.


What about Stablecoin competition? CBDCs might just be the main competitor to fiat-backed stablecoins as long as high trust toward the Central Banks exist. However, the cryptocurrency industry was built as a hedge to the whole industry, and decentralized stablecoins will provide exposure to an asset that is theoretically uncorrelated to CBDCs. Would you trust your money with the Central Bank of Greece during the early 2010s financial crisis if they had a CBDC, for example?


What about Bitcoin and other pure cryptocurrencies? CBDCs are simply a different beast altogether. No one can offer the privacy protection of Monero, Z-Cash and Dash, and Bitcoin’s value is proven to be uncorrelated to traditional markets and will lead the price of the rest of the blockchain industry. Virtual Machine platforms, like Ethereum, EOS and Cardano, are also significantly different to non-smart contract capable CBDCs, and it looks unlikely that any of the CBDCs researched as the moment will aim to create the smart contract functionality Ethereum or stablecoins like Libra and Terra are focusing on.


Lastly, non-backed, algorithmic stablecoins are multi-coin systems that aim to stabilize their price by expanding and contracting the supply of their token. Isn’t that similar to what central banks do since the end of Bretton Woods?


It seems that highly innovative projects, like said algorithmic stablecoin, will only flourish when trust and ever expanding usage of their system is established. For that to be the case, it is very likely that a central bank will have to support it – which does beat the purpose initially, but these systems can then be tested accurately, iterated upon securely, and decentralized later on.


Does this seem like an impossibility? Well, surprisingly no! Outgoing head of the IMF, Christine Lagarde, has brought up the possibility of Central Banks acting as a lender of last resort to blockchain businesses as they enter the mainstream financial markets. Of course, existing regulations will need to apply to these companies before any such formal action takes place. But as Ms. Lagarde takes the helm of the European Central Bank, the world will follow closely and monitor the way she handles an industry created to leave her out of a job. Until November 1st, when she takes over the ECB, the IMF paper on the Rise of Digital Money is a must-read for anyone interested in the topic.


As a final word, the world of money is changing, and the efforts of cryptocurrency entrepreneurs seems to have been successful in pushing the status quo in ways that seemed impossible a few years back. CBDCs, in retrospect, seem like an inevitable response to Bitcoin and Stablecoins. Now is the time. Let’s see what these entrepreneurs can accomplish, and how CBDCs will affect their projects’ future.


- Xenofon Kontouris, writing for Stable Report.