In a new book on Cryptocurrencies: Money, Trust, and Regulation, Dr Oonagh McDonald, a regular contributor to the Institute over our three decades, probes the challenges, opportunities and threats that cryptocurrencies pose to existing fiat currencies and their potential to change how global finance operates.
Beginning with bitcoin, she charts the rise of cryptocurrencies over the past decade, including the failures of existing regulatory frameworks and the many fraudulent initial coin offerings. The potential for Libra, Facebook’s blockchain-based payment system, is considered in depth. The book examines the motivations of central banks as they become increasingly interested in the opportunities for an alternative global stable digital currency and assesses their experiments with blockchain, smart contracts and digital tokens. The future of cash is also considered. The book concludes that notions of trust and credit will ultimately protect commercial bank money from the threat of new digital currencies.
Introduction by George Littlejohn MCSI
CISI senior adviser
A central bank digital currency (CBDC) is often confused with digital records of transactions held in our bank accounts. A CBDC is a digital form of central bank money that is different from the balances or settlement accounts held by the central bank. It is a digital payment instrument denominated in the national unit of account that is a direct liability of central banks. The Bank of England clarifies this further by saying it would allow households and businesses to make electronic payments issued by the Bank. They would be digital tokens of pound coins and notes. Cash would not disappear if the demand for it remains. That all sounds straightforward enough, and reassuring for many in that cash would remain, except that the demand for cash could be nudged out of existence.
A 2021 survey of central banks by the Bank for International Settlements finds that 86% are actively researching the potential for CBDCs, 60% are experimenting with the technology and 14% were deploying private projects. BIS has established an innovation hub to apply technology research and prototypes with central banks around the world. The central banks themselves are (or should be) safeguarding trust in public money, maintaining price stability and a safe and resilient payments system. CBDC is always touted as a way of offering fast and efficient payment systems and increasing financial inclusion. The former can be achieved without CBDC and the latter is more easily achieved in the UK and the EU by requiring banks to offer basic bank accounts to those on low incomes. In the UK, fewer than half a million live in households without access to a bank account, out of 28.1 million households.
It is often assumed that Sweden with its low levels of cash use would be the first to introduce CBDC, but that may not be the case. Resistance from many elderly people who do not wish to or cannot afford to buy and use the technology for small cash payments is one factor. And Sweden’s Civil Contingency Agency advises everyone to keep small denomination notes at home in case the payments system crashes. A Parliamentary Commission on CBDC was established in December 2020 with extensive terms of reference, including the effects on the public, the effects on society’s preparedness for crises and wars, and on countering money laundering and terrorism. Privacy of transactions will also be a major concern. The Commission will report in November 2022 and the decision will be taken some time after that by the Swedish Parliament.
The risks here are not only the lack of privacy, but even worse, the possibility of control over how individuals are allowed to spend their own money The Bank of England has proposed a specific structure, which involves a central bank account, accessed through the payment interface provider (PIP), which is responsible for the know your customer requirements. All transactions are recorded on the Bank’s core ledger, which will have to be a fast technology platform, strongly protected from cyber attacks. People can transfer cash from their accounts to a digital ‘wallet’ authorised and regulated by the authorities. Only the PIP can connect with the core ledger through the application programming interface. The risks here are not only the lack of privacy, but even worse, the possibility of control over how individuals are allowed to spend their own money, using smart contracts. Such controls may not be possible at present, but the rate of technological innovation is very fast, so extensive programming may be possible in the future.
The Bank does not have the powers or the will to do so at present. Those decisions will be in the hands of government. Legislation will have to be introduced in the current Parliament, and the present administration is likely to decide against the use of such powers. But one Parliament cannot bind the next, and the decisions of the current governor may change with future governors. These are powerful and tempting tools. The introduction of CBDC by China is precisely to use the CBDC to exercise its ‘social credit’ system even more effectively than it does already.
Furthermore, the introduction of CBDC could give the central bank more immediate and effective control over monetary policy. It would undoubtedly weaken the commercial banks and their ability to provide credit. The Bank’s proposals, for example, could lead to 20% of the commercial banks’ deposit base, or all the uninsured deposits, moving out of the banking system to the central bank. This together with the loss of revenue stream from payments means that the commercial banks would have to fund themselves from long-term wholesale debt. Sir Jon Cunliffe, the deputy governor, shrugs off the issue: “Banks would have to adapt.” But that may well lead to serious constraints on the credit market, which the Bank could not fulfil.
Central banks are eyeing China’s rapid progress on CBDC and, one suspects, are motivated by the ‘fear of missing out’. But CBDC is a solution looking for problems to solve. The problems the solution seeks to solve can all be solved with other readily available tools and that is already happening.
Oonagh McDonald CBE is an international expert in financial regulation, having advised regulatory authorities in a wide range of countries, including Indonesia, Sri Lanka and Ukraine. She was formerly a British Member of Parliament, then a board member of the Financial Services Authority, the Investors Compensation Scheme, the General Insurance Standards Council, the Board for Actuarial Standards and the Gibraltar Financial Services Commission. She was also a director of Scottish Provident and the international board of Skandia Insurance Company and the British Portfolio Trust. She is currently senior adviser to Crito Capital. She was awarded a CBE in 1998 for services to financial regulation and business. She now lives in Washington, DC.
oonagh.mcdonaldcbe@gmail.com