Would a CBDC accelerate wider adoption of the overall cryptocurrency market?

On November 12, the International Monetary Fund (IMF) has released a new research paper on the pros and cons of a central bank digital currency (CBDC). The research paper `Casting Light on Central Bank Digital Currency´, focuses solely on the domestic effects of digital currency. The central bank digital currency is believed to fulfil three key public policy goals: (i) financial inclusion, (ii) security and consumer protection, and (iii) provide privacy in payments.

  1. Financial inclusion: The central bank digital currency can create financial inclusion, as people can easily access a cheap and efficient payment system (e.g. with the phone).
  2. Security and Consumer Protection: A CDBC would act as a backup means of payment. In addition to that, it could boost competition by offering a low-cost and efficient alternative.
  3. Privacy in Payments: A CBDC would allow users to remain anonymous for legitimate and legal reasons, while on the other hand law-enforcement agencies still have the possibility to investigate illegal activities.

The Managing Director of the IMF, Christine Lagarde, has again acknowledged the fact that the perception and requirements of today’s money are changing. In her speech at the Singapore FinTech Festival in Singapore, she stated that e-payment providers such as AliPay and WeChat “respond to what people demand, and what the economy requires”. In addition to that, she also said that “we (the IMF) should consider the possibility to issue digital currency. There may be a role for the state to supply money to the digital economy”.

Central Bank Digital Currencies (CBDC)

The Central Bank digital currency is essentially based on the same principle as existing cryptocurrencies. The difference is that in this case the Central Bank would be in complete charge of the decentralized payment system and not a group of private individuals/entities. Consequently, the Central Bank would control the issue of cryptocurrencies and guarantee a fixed exchange rate between digital currencies and fiat currencies. Knowing their statutory duties and the fact that the usage of cash is declining, the Central Banks are inclined to develop and implement a digital currency that would contribute to the overall benefit of the society.

Some central banks, including the world’s oldest, Sweden’s Riksbank, have already created their own cryptocurrency in response to the declining influence of cash as a means of payment. More than 50% of today’s population in Sweden have installed the Swish mobile app, which allows people to transfer commercial bank money with immediate effect. The e-Krona project in Sweden, is one of the potential answers to provide the general public with a central bank digital currency. This project is expected to be finalized in late 2019 and we will certainly give our clients a detailed analysis of the overall results.

Why have central banks been hesitant until now with CBDCs?

For one, making digital central bank currencies widely available could also create a threat to the existing financial system. In times of crisis, a direct access to CBDC could create a run from private banks to the state. Taking it a step further, it could potentially even create cross-border shifts with capital being moved away from political and/or financial instable countries towards central bank digital currencies of stable countries.

The impact of the first scenario could be very significant, considering the fact that banks need deposits in order to make loans and investment decisions. As an ultimate result, the private banks would need to borrow long-term funds to finance long-term loans.

Furthermore, private banks could lose the income they make from facilitating payments.

‘The private-public partnerships between private banks and Central Banks’ solution that Ms. Lagarde presented during her speech at the Singapore Fintech Festival could potentially be a good compromise.

Is a CBDC a necessity for the future of blockchain and cryptocurrencies?

The question is not necessarily, whether a CBDC would be good for central banks. As much as it can benefit the central banks, the crypto economy is also in significant need for stablecoins and a CBDC. Stablecoins are needed to effectively fulfil on all the promises of smart contracts. Ideally, we would have something that has no credit risk and has assured liquidity. For instance, we could get a commercial bank to issue a coin that is fully backed and has no credit risk, but it would still have liquidity risk, since the commercial bank cannot print new money. The Central Bank on the other hand has all their assets fully on-chain, which is the reason why it could even better fulfill on all the promises of smart contracts.

According to Mr. Roubini, a CBDC would immediately displace cryptocurrencies. In his recent article “Why Central Bank Digital Currencies will destroy cryptocurrencies”, he argues that cryptocurrencies are not scalable, cheap, secure, or decentralized. While he believes that a CBDC would complete take away the need for other cryptocurrencies, we believe that there is room for both. In fact, an effective CBDC would most likely further grow the people’s confidence in blockchain and cryptocurrencies. It will be key that the Central Banks fully acknowledge the benefits that come with using smart contracts for the various use-cases and how a CBDC can play an instrumental role in this.

To conclude

The aforementioned implications, lead us to believe that the adoption of CBDCs will still take some time. The demand for cash is consistently declining, while retailers/banks in both advanced and developing economies are also trying to discourage cash transactions, given the related costs. The Central Banks will most likely first focus on improving the current payment system and maintaining existing infrastructure, before fully acknowledging that the future lays in blockchain and cryptocurrencies.

To our investors, we have concluded that the emergence and demand of Bitcoin and the underlying blockchain technology has attracted significant attention of institutions and governments, and is consequently slowly starting to disrupt the current financial system and wider economy. While the underlying trust in cryptocurrencies (such as Bitcoin and Ethereum) is based on the technology, the IMF and Central Banks still put a high emphasis on the importance of proper regulation. Even though the current model of CBDC’s and governmental bodies are not yet ready for market implementation, it clearly shows the tendency towards and possibility of overall cryptocurrency adoption. Once the principle and use-cases of cryptocurrencies become more mainstream through the issue and approval of state-backed cryptocurrencies, the entire crypto market would benefit significantly.

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