Central Bank Digital Currencies in the Fog
Martin Bartels
23 May 2022
What is Central Bank Digital Currency (“CBDC”)?
Presently more than 80 central banks are considering the introduction of CBDC systems. The plan is to maintain legal tender cash accounts directly with a central bank for all types of customers, on a credit basis that will possibly be interest-bearing, through which the account holders can receive or dispose of funds. In this system, deposits will be liabilities of the central bank. The balance on a CBDC account is intended to be an equivalent to cash, not a substitute for it. Use of the account is to be free of charge and overdrafts will not be possible. The technology needed for the use of such accounts will be the same used for accounts at commercial banks.
Why are central banks working on CBDC?
Fresh electronic payment technologies, as well as competition and innovation from fintech start-ups have significantly improved payment systems and brought down costs in recent years. So it is quite surprising that central banks are planning to move into an area which is the home turf of the regulated commercial players.
This article relies mainly on the arguments made public by two central banks working on CBDC. These are the European Central Bank and the Bank of England which has issued a Discussion Paper.
Both institutions’ interim conclusions are complementary and tend to favour the project.
The US Federal Reserve has a sharper focus on the monetary policy and technical implications and raises questions about CBDCs’ impact on the private sector.
The Fed's former Vice-chair Randal Quarles openly argues against the project.
So what arguments do the advocating central banks put forward?
“Citizens' payment habits are changing, the share of cash payments is decreasing and preferences are shifting towards electronic payments”
While this statement is true, financial service providers do not appear to have a bottleneck in serving demand. So then, why the need for change?
“Central banks cannot become insolvent”
It is correct that commercial banks can lose the ability to repay deposits. However, there are usually state-regulated deposit insurance systems that cover the risk of bank failure. Furthermore, it is not historically accurate that central banks cannot go bankrupt. In fact, central banks are not infallible. They are run by human beings who can misjudge threats and make wrong decisions with fatal consequences. If then, a recapitalisation by the nation state is not politically possible for whatever reason, the bulwark cannot remain stable.
“Central banks should offer solutions for the unbanked or underbanked population”
In every country there are legal regulations for the opening of accounts, the core of which is the clear identification of the account holder (“KYC”). Since a central bank has no human and technical resources for these processes, it would be compelled to outsource them to commercial banks. Thus there is no plausible argument to be made that a CBDC account would lower the barriers against opening accounts.
“Simplicity of CBDC accounts”
The use of bank accounts is as safe and simple as the available technologies and government regulations allow. If a competitor finds simpler solutions, other institutions will follow. It is desirable for a central bank to bring further improvements to the market, but is that likely, given that public sector institutions often have little incentive to improve the users’ experience?
“Interoperability with commercial bank accounts and cash”
The seamless integration of a new means of payment into the existing infrastructure of accounts and ATMs is a prerequisite for acceptance and so this practical requirement cannot come as a surprise. This, then, would not give CBDC accounts a competitive edge, as they would not be unique in this function.
“Reduction of the likelihood of bank runs in the event of an economic crisis”
According to the ECB, the availability of CBDC accounts would reduce the likelihood of bank runs at commercial banks because depositors would see the account at the central bank as a fallback option. However, examples from the 1930s, a time without deposit systems, are cited as supporting evidence. Furthermore, why would a central bank account be safer than a commercial bank account with the benefit of a deposit insurance scheme?
“Limitation of deposits”
The amount of deposits per account will need to be limited because a central bank must not cannibalise commercial banks. The latter need deposits to maintain their businesses. Even though a much higher inflow may not be likely for the previously unbanked or underbanked, it would be perceived as a restriction to be denied the possibility of a higher balance. Nobody likes the idea of being curtailed.
“A central bank has no interest in the data generated by the use of CBDC accounts”
Payment service providers are required to maintain significant technical and human resources to detect and immediately report any suspicious or illicit flow of funds to the authorities. A large number of smaller transfers, for example, can be an indication of money laundering.
If a central bank's system were abused for money laundering purposes, for example, and for some reason the central bank did not react promptly and vigorously, the reputational damage would be very painful.
If the movements on CBDC accounts were not very closely monitored and analysed, their improper use would not just be a possibility, but a certainty. Therefore, robust resources would need to be deployed that are at least equivalent to those of very conscientious private institutions.
“Reduction of transaction costs”
Since CBDC account providers would be obliged to devote expensive resources to monitoring payments in line with the law, they could only compete in the market with a free service if they subsidised their account management out of their own deep pockets. This would result in a distortion of competition between the public and the private sector.
“Alternative to ‘stablecoins’”
‘Stable coins' offered by the crypto industry are linked to currencies issued by central banks, but are reached by central bank steering instruments. Therefore, the Bank of England considers CBDC money a better alternative. The Bank for International Settlements is more explicit and considers Stable The Bank for Intetnational Settlements is more explicit and considers Stable Coins as a serious risk factor.
At least one central bank sees CBDC as a means to fend off cryptocurrencies.
Blockchain technology?
While it has its supporters, there is no technical reason why blockchain technology must be used for CBDC accounts. Some blockchain solutions may seem attractive because of their reliability, but they do not yet offer the speed that would be necessary.
The Chinese approach is different and consistent
The People’s Bank of China is promoting the goal of a cashless society. In this respect it is the most advanced central bank in the world and has been conducting pilot projects to perfect its “e-CNY” system with the goal of processing 300,000 transactions per second. The “e-CNY" is set to compete with the existing and very efficient private systems AliPay and TenPay in which a central ledger allows the operator to monitor exactly who has made which payment to whom and users are easily identified by their telephone numbers.
As it cannot control them, the country is striving to keep cryptocurrencies out of its territory as well as aiming to keep big tech from dominating the market. Thus CBDC is being offered as an attractive alternative.
Conclusions
This article does not outright concur with nor reject the Chinese goals and strategies. Nevertheless, it is clear that the Chinese strategy is consistently oriented towards defined goals.
The European Central Bank and the Bank of England would not endorse Chinese goals. From the arguments made known, however, convincing motives for supporting their own CBDC projects cannot be clearly discerned. However, it cannot be ruled out that the European institutions are working towards goals that have not yet been disclosed. There is no point in making conjectures about this.
If, however, the powerful CBDC "Project Hamilton" system developed by the MIT and the Federal Reserve Bank of Boston were adapted to the needs of the private sector, there could be prospects for substantial qualitative progress. Something valuable can certainly be derived even from a project that is still covered in fog.
POST SCRIPTUM on 17 June 2022
A recent statement by Fabio Panetta, Member of the Executive Board of the ECB, at the Committee on Economic and Monetary Affairs of the European Parliament, suggests that for the European Central Bank, the containment of the whole cryptocurrency market is the main motivation for the creation of CBDC:
"And if we don’t act, we will also see increasing confusion about digital money. Crypto-assets are a case in point.[ 10 ] Unbacked crypto-assets, for example, cannot perform the functions of money. They are neither stable nor scalable. Transactions are slow and costly. And, in some forms, they pose a danger to the environment and to other societal objectives. Stablecoins, meanwhile, are vulnerable to runs, as we have recently seen with algorithmic stablecoins. In this context, it is vital that any remaining regulatory gaps in the crypto-asset ecosystem are closed."
POST SCRIPTUM on 23 June 2022
A new BIS statement dated 21 June 2022 clearly indicates that the institution classifies "crypto" as dysfunctional and disturbing. Clearly this is what a gauntlet looks like.
To set the stage
Lao Tzu’s words sum up a dramatic contemporary scenario: While in some parts of the world people are increasingly affected by water scarcity, others face the growing threat of too much water due to extremely heavy rainfall and rising sea levels.
While the poem captures the ambivalence of water perfectly, the words "soft and weak" also seem to describe the way modern civilisations have responded to it. Their foggy perception and sluggish action is just as dangerous as the threats themselves.
Why Water?
The focus of this essay is to use the prominent example of water to help identify concrete approaches for dealing rationally with the issue of climate change. Climate change affects us in many ways, including the expansion of deserts, forest fires, the salinisation of soils, landslides, extreme weather events, agricultural crop losses, loss of biodiversity, spread of disease and human and wildlife migration.
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Scientists and engineers have laid the foundations for our prosperity. And only these elites can show us the way to overcome the harmful externalities of these very engines of our wealth. This article supports the thesis that we are technologically and organisationally in a position to successfully meet these challenges, step by step.
One obstacle to the mobilisation of existing resources lies in the fact that the general public has only a vague understanding of the issue. They do not realise that, unless we make controlled sacrifices, nature will impose uncontrollable sacrifices on us.
We urgently need to overcome the human tendency to trivialise and understand with our minds and hearts what will happen if we do not listen to the guidance of our scientists and engineers. However, while these experts hold the keys to the right strategies, they are only trained to communicate with other scientists. This leads to a situation of misunderstanding and therefore a lack of adequate action.
Blurred perception of facts
Every day, we are all exposed to an overdose of reports about minor and major disasters in all forms of media. We more or less defend ourselves against this by ignoring some news, i.e. reducing the strain on our nerves by filtering information. It is human nature to rely on the mostly correct assumption that unpleasant developments will eventually end and change for the better. In the case of climate change, however, looking away and hoping things resolve themselves doesn’t appear to be a winning strategy.
A wealth of scientific analyses on climate change is available to everyone, but these are mostly comprehensible only for other scientists.
We should openly acknowledge that most people in the northern hemisphere have a sense of empathy for people "in the south" who are plagued by overpowering rains, flooded lowlands, islands disappearing into the water, eroding coastlines or droughts. However, the geographical distance and lack of awareness of the frequency of such disasters dilute solidarity. Collective psychological repression can set in quickly.
Most people in the northern hemisphere do not consider an increase in average temperatures of a few degrees to be alarming. Many even express relief that the winter is often milder than in the past. Loud protests by campaigners are experienced and understood by most citizens as a disturbance or perhaps exaggerated fearmongering.
At the level of policy, scientifically informed decision-makers attend international conferences on climate change, where they negotiate with other decision-makers on action plans that have no teeth but are presented as hard-won progress. And they are increasingly supporting “green” sectors of the economy. However, they are often reluctant to share the full extent of their knowledge about the problem because they do not want to jeopardise their recognition by “rocking the boat”.
The factual impact level is decisive for citizens
There is controversy about the interplay of causes of climate warming (industrial emissions, volcanic activity, ocean currents, etc.). We don't want to debate that here. What is more relevant are the changes in global average temperatures and their trends, as determined by scientific methods.
Instantaneous interruption or reversal of a climatic process?
Changes to the climate are not new in human history, and certain events have triggered reductions in temperature. A striking example of a break in climatic developments is the eruption of an Icelandic volcano in the year 536 CE, whose dust made the atmosphere in the northern hemisphere so opaque to sunlight over a period of more than 20 years that temperatures fell drastically ("Little Ice Age").
Recently, it has been hypothesised that ice ages were triggered by asteroids.
It may be tempting to pin our hopes on the possibility of such events helping us to mitigate climate change, but while we cannot rule them out, events of this kind are rare and unpredictable, we must not include them in projections. It would be absurd to hope for random external causes that could interrupt or stop the progress of global warming. While hope is a human propensity, it is not suitable for contingency planning.
Our real bottleneck
What is preventing us from taking appropriate action to minimise and reverse the rise in average temperatures?
Citizen perception of the nature and dimension of the threat is inevitably blurred, because the daily reports from the media are mostly unstructured and not comprehensible to non-scientists. The reports do not allow us to recognise the essentials.
Citizens need an overview that is communicated in an honest, understandable and clearly structured way. Only when citizens have realised the nature and scale of the problem will decision-makers have the courage to take action with determination. In essence, it is about legitimising protection strategies that are considered unpopular today.
Given that citizens do not have access to graspable knowledge, we have a transformation problem. And this can be overcome if science presents the overall scenario from a certain distance. Figuratively speaking: It is not about describing every pixel point of an image, but about showing the image as a whole. The holistic representation deviates from the usual approach of scientists, because each of them is professionally held to focus on "pixel points" in their respective area of specialisation. This is the only way science makes progress, but that's not what is needed here.
The contours of the hologram can be communicated in an understandable way using e.g. the key points mentioned above:
If the effect of a detail is not legible, the presentation of the measurement can be improved. In particular, the exponential impact of very small changes in average temperatures in the atmosphere goes very much against human intuition. We can compensate for this disadvantage in perspective: Instead of referring to changes in temperature in degrees Celsius, we should consistently communicate changes in basis points, i.e. in hundredths of a degree Celsius. For example, labelling a temperature rise as "32 basis points" would be correct and would make the difference easier to comprehend than "0.32 °C". This method is a common practice in the financial industry. There, too, this method of representation is helpful in raising awareness that a small change can have massive implications.
Comparing our planet with human bodies helps us to comprehend the effect of changes in temperature: If your body temperature rises by 1° Celsius, you have a fever and are not feeling well. If the temperature rises by 1.5 or even 2° Celsius, you are very ill and hardly able to work. It is similar with our planet: If it experiences increases in average temperatures of this magnitude, it shows the symptoms of a "serious illness". However, this "fever" does not go away after a few days.Truthful and comprehensible holographic description will work like a call to action as sensible citizens will refuse to accept the idea that their lives, that of their children or that of their grandchildren, will be exposed to significant and unparalleled danger.
Here is a simple example of a call to action: It is true that the onset of toothache does not necessarily trigger a reaction in us straight away. We are perhaps still hoping that it will go away on its own. But at some point we turn to the dentist for help. We may later find the dentist's bill stressful, but the relief of finding a solution to the problem outweighs this. It is necessary that we anticipate, that we sense the expected greater pain, in order to take the initiative.
Governments will only act vigorously when informed citizens demand it vigorously. There has been pressure from sections of the population for a long time, but its direction has always been vague and therefore not sufficiently effective.
And like a dentist, a government cannot act for free, but will send bills to taxpayers. The later the comprehensive strategy is implemented, the higher the bill.
Defensive and offensive measures
The necessary government action plans are not the subject of this article. It should only be mentioned that defensive measures are necessary first, e.g., improved meteorological warning systems, raising and strengthening of dams and dykes on the sea coast and rivers, preparation for the abandonment of non-defensible areas. In addition, measures are needed to halt the dangerous trend and then slowly reverse it. These essentially consist of avoiding emissions and removing greenhouse gases from the atmosphere.
Desperate measures?
The keyword for desperate actions is "geoengineering". This could imply approaches such as making either the atmosphere or our oceans absorb less sunlight or bind more CO2. While these approaches sound exciting, they are not fully developed and run the risk of causing irreversible damage. As such it is unlikely they will be used.
Sabotage of the communication of scientific work
There are two groups working against open and fair communication between science and the citizens.
Refuseniks who are not interested in facts work against this. They are used to believing their own feelings and those of their friends from social networks. There should be no discussion with them, because deviations from their assumptions act as fuel for them. Science will not lead them out of their dream worlds.
Then there are the sceptics, who may have expert knowledge but only select those parts of it for their thinking and communication that seem to support their rejection of action. This is a dangerous species, because “expert” sceptics can claim some credibility and can disrupt societal communication successfully. The only way to weaken these people is to persistently ask them for better and well-founded alternatives. Then they have to provide verifiable answers or quietly hoist the white flag.
Acknowledgements:
My heartfelt thanks go to Professor Reinhard Gast. As a practising geologist and experienced researcher, he has helped me to grasp the exponential impact of seemingly minimal changes in the temperature of our atmosphere, similar to our own bodies, and the uniqueness of the current situation.
Authorship disclosure:
Fully human generated