The great digital currency dilemma

Having central bank digital currencies is a great idea. It's also fraught with difficulties including how to protect banks

7th Oct 21, 8:57am by David Hargreaves

Central bank digital currencies (CBDCs). They sound like a great idea to me, given that nobody wants to use cash any more.

So, how's about we get on and introduce one?

Well, not so fast, the central banks are saying, including our own RBNZ - although it is clearly keen on the idea of having one. Just not yet.

The RBNZ's big dump of Future of Money material last week, seeking public views, and commenting at length on digital currencies was perhaps illuminating in ways our central bank didn't intend.

Like the torrent of information on the subject now being produced by the Bank for International Settlements (BIS) I think what's being demonstrated is a profound nervousness of what the impact and unintended consequence would be of central bank digital currencies.

But, and even stronger than that, there's a profound fear of what might happen if globally, central banks DON'T move into the digital 'space' - and some private entity gets there first, with a 'stablecoin' - a privately issued digital currency backed, probably 1-for-1 by actual assets such as for example physical American dollars.

It's no coincidence at all that the central banks around the world suddenly got a whole lot more interested in digital currencies after Facebook casually dropped the fact in 2019 that it was involved in a project for a stablecoin, originally called Libra, now called Diem.

Facebook was primed and ready to go potentially within months till the central banks got involved. And there's no doubt that leveraging off its world domination, a Facebook-led digital currency could have quickly become ubiquitous, particularly in developing nations.

So, with all the work now going on with the central banks there's the sense that they are doing the digital currency thing in large part as a defensive measure. They are doing it to stop others doing it.

And you can understand why.

Imagine if a stablecoin was introduced that became popular enough that very large numbers of Kiwis started using it. They would remove money from NZ bank accounts. They may well be transacting in something that's based on an offshore currency, for example the US dollar.

There's the potential for banks to lose business hand over fist. And there's the potential for the central bank to start losing control over monetary policy and its ability to control things using implements such as the Official Cash Rate, as our RBNZ does.

So, an interesting juggling act is required. Don't get all adversarial with those that might introduce alternative coins, maybe tolerate one or two such coins that agree to be heavily scrutinised and/or regulated, and seek to produce your own form of digital currency that ensures that these alternative stablecoins don't ever become the ruling currency.

And they wouldn't, or shouldn't become the ruling currency, because obviously the central bank always has the advantage that its currency would be 'real' and effectively guaranteed by the Government. It would be like cash. Guaranteed. And no private business would be able to compete with such a level of security.

Okay, that's sounding fair enough so far. But then we get into another interesting juggling act.

The banks. What about them?

They offer digital currency of course. It's what we all have in our bank accounts. But it is not guaranteed other than by the bank itself.

That's generally good enough though. And folk are happy to accept payments we make out of our bank accounts to them.

What about if and when a central bank digital currency comes along then? Well, that's a game changer.

If the central bank digital currency is made available to the general public - and indications are any RBNZ-introduced one would be - then this would trump money coming from a private bank account as any means of payment.

Remember the old days when it was necessary to get a 'bank cheque' for some transactions to give the recipient of the money extra comfort that they would actually get paid?

Well, in future, why wouldn't a landlord, for example, insist that they get their rent paid for by bright, shiny RBNZ digital dollars? Rather than that funny, private bank-issued stuff?

It's not hard to envisage a situation where demand for the central bank digital currency becomes very high. And it's not hard either to envisage a situation whereby the individual, instead of using a private bank transaction account, chooses to use the central bank as their transaction account.

The RBNZ has certainly thought of that and one early suggestion it has made is to maybe charge people interest on holdings of digital currency through the central bank.

That all sounds quite awkward though.

And it sounds like what it is - the central bank putting limitations on the usefulness and potential popularity of its own product, in order to stop the private banks losing out.

It is this desire, the need, to protect the banks - that can be seen both in what the RBNZ has produced and what is coming out from BIS - that could ultimately act as a big drag on the successful introduction of central bank digital currencies.

But if the central banks don't move, then others may well move first. And then we do potentially get the situation where private banks lose business and central banks start losing monetary policy control.

What would be the reaction? Could the authorities simply start making private issued digital coins illegal? Maybe. But that would be Draconian and would not sit at all well with the 'crypto crowd' who follow crypto assets and believe in them with an almost religious fervour. And there's a lot of it about. The crypto assets market currently has a market value of over US$2 trillion. There's a lot of it about.

So, central bank digital currencies. A great idea, but clearly an idea that has all kinds of ramifications.

Personally, I think central banks will have to bite the bullet and they should do so sooner rather than later. The procrastination that, I think, is going on globally needs to stop.

I think it has to be accepted that central banks going down this path will have an impact on banks.

Holding off introducing digital currencies because of concern over what happens to the banks though risks the private-led coin scenario. And that would hurt the banks too.

This is a truly massive issue the world needs to face up to. I hope the central banks are bold, because I think they need to be. Disorder is the potential alternative.

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54 Comments

by powerdownkiwi | 7th Oct 21, 9:01am 1633550483

As the links I referred you to point out, David, the underwrite versus expectation question is the background to this. Until issued proxy - in whatever form; it's still only proxy - matches proven supply at a future date, the system is in trouble. Issue ever-more proxy, and you inevitably get scarcity-induced inflation.

But the problem comes when the proven supply cannot match expectation; the rent on proxy (otherwise known as interest) has to fall to zero, then go below. It's the only fit that fits. And we're seeing it all over the world. So banks are displacing someone/something else if they're charging interest, from Peak Resource Supply, on. Increasingly parasitic on a system with ever-less surplus energy.

So why not bypass them? If they want to revert to pre-usury accountancy-for-a-fee, fine.

by JohnTrz | 7th Oct 21, 4:25pm 1633577134

Call me stupid, but who needs private banks? If I could have an account with the RBNZ, which is the issuer of the cash I use, accessible by an efficient electronic wallet, I would dump my private bank in an instant. Or ... I would go to that private bank if I wanted some other service, such as borrowing money from that bank for a mortgage, or lending money to that bank to earn fixed interest, or using that bank's credit cards because my RBNZ account was temporarily running on empty. But all those operations are available from non-banks. So who needs banks? Gimme the RBNZ!

by JohnTrz | 23rd Dec 21, 8:02am 1640199758

https://www.reuters.com/markets/rates-bonds/cambodia-aims-hybrid-digita…

by LASSET | 7th Oct 21, 9:23am 1633551807

That's a great summation David. CBs absolutely need to start planning for this, they can see the writing on the wall. But as you've pointed out, there's a number of rather large pitfalls they need to negociate... And the guaranteed loser in all circumstances is the retail banks, who are going to get squeezed from all sides. They're going to be under pressure from CBDCs, neo banks, fintec and crypto.

Of course the only point you didn't touch on, is once this is normalised, there's a not insubstantial chance that people would rather not use a CBDC (With all the problems of our current system + massive privacy and liberty issues) or a corporate issued stablecoin (Yeah no thanks Zuck!)

You didn't consider that by the stage we get there, perhaps people might actually want to use a completely decentralised form of digital money? Maybe one that wont be debased, and cannot be easily taken from them. Maybe one that has a known issuance and a proven track record as sound money and an incredible store of value over the long term. That people can use to make an instantaneous peer to peer transaction directly to anyone in the world for little to no cost. A transaction that cannot be stopped, that is all running on the worlds most secure network. I feel like there might be something in that...

by Nzdano | 7th Oct 21, 10:47am 1633556871

A global currency has considerable implications in that it doesn't allow comparitive revaluations of currency between countries.

Like Greece using the Euro but to a far greater degree.

It could do all sorts of strange things with the competitive balance of economies.

by J.C. | 7th Oct 21, 11:03am 1633557836

Nice perspective there Lassie (hope you don't mind the good natured play on words there). Your point about the threat retail banks is salient. Personally, I have no issue with seeing them go. But if you look at society, particularly in NZ and Australia, you can see the influence of retail banks is pervasive: they drive our property bubble which is the primary savings vehicle for h'holds and capital base for our SMEs; they are some of our largest companies (look at their weight and influence on the ASX); and they're really the mechanism by which the money supply is expanded.

So what I'm saying here is that our socio-economic structures would collapse if they were massively disrupted overnight.

There's a certain irony in that CBDCs seem to have evolved partly because the banking sector itself has driven the destructive tendencies of money creation. Ultimately, I do not see CBDCs as some kind of solution. They're a band aid if anything. They do not improve currency as a store of value nor do they protect the purchasing power of people's incomes.

by LASSET | 7th Oct 21, 11:33am 1633559616

'So what I'm saying here is that our socio-economic structures would collapse if they were massively disrupted overnight."

I agree. I used to think this was a major concern with hyper bitcoinisation, but I'm not so worried about it any longer. With many other industries, disruption from technological change has happened very quickly. But due to the stronger ingrained sociological and emotional bonds to 'money', I'm now inclined to think that this is going to be a slow bleed out over decades for the old guard, death by a thousand cuts. Those who innovate and integrate will survive. As you say though, here in NZ our (Australian) banks are almost purely a residential property lending service, so hard to know what will happen there...

by youngdumbandbroke | 7th Oct 21, 10:57am 1633557427

"And the guaranteed loser in all circumstances is the retail banks, who are going to get squeezed from all sides."

Good. An unnecessary intermediary that clips the ticket.

by J.C. | 7th Oct 21, 11:03am 1633557780

Good. An unnecessary intermediary that clips the ticket.

They clip the ticket but they also have the right to lend into existence. No other industry has this privilege. Do I say it's wrong? Not entirely. But it does contribute to the destruction of any NZD I want to (or have to) hold

by youngdumbandbroke | 7th Oct 21, 11:33am 1633559639

I say it's wrong as it has lead to the entire globe to live beyond it's means, detached from the physical assets/resources that this debt has been leveraged against.

by Rob Reid | 8th Oct 21, 1:38pm 1633653533

Someone will still have to do a bunch of due diligence and risk assessment on loan applications.

I can't see the RB being interested in taking on thousands of staff to do routine work like that.

by Nzdano | 7th Oct 21, 10:44am 1633556652

How would mortgages work in a CBDC world?

Presumably RBNZ wouldn't want to be getting into this and it would stay with regular banks.

What would the impact on their fund sources be?

Banks might end up basically finance companies.

Definitely lots of implications.

by J.C. | 7th Oct 21, 10:58am 1633557533

Yes. Read my comment above. The retail banking sector is the primary mechanism by which the money supply is expanded for the average Joe and it is the source for mortgages for the driver of the housing bubble as the banks go on their merry way of lending into existence.

by Nzdano | 7th Oct 21, 12:50pm 1633564248

The money supply needs to be able to expand at roughly the rate the economy is growing to avoid major deflation. How that looks under a CBDC system I'm not sure.

What happens in a global Bitcoin based economy when everyone is "HODL"ing and noone spends?

by Pacman_46 | 7th Oct 21, 11:31am 1633559476

If only there was a pristine, scare, secure, digital asset that could be used as collateral by lending institutions.

by J.C. | 7th Oct 21, 11:36am 1633559779

If only there was a pristine, scare, secure, digital asset that could be used as collateral by lending institutions

I think we all know what you're alluding to there Paccy!! .

by avatar99 | 7th Oct 21, 11:26am 1633559161

Fascinating article, thanks. Might bring a great reset on how we view money, our money supply, debt, etc. What worries me the most is orthodox economists don't seem to have a great understanding of that and the non-orthodox have competing views. Not sure there is an incremental way to bring change either.

by J.C. | 7th Oct 21, 11:34am 1633559659

Honestly speaking, this disruption really poses an existential threat to the central bankers' whole lives (academic, professional) and what they believe in. Remember when Alan Greenspan said in public "I was wrong." He gained a lot of my respect for being able to admit to that. He then stepped back and disappeared from the limelight. Particularly in the Anglosphere, the new set of central bankers just carried on and amped up the destruction that Greenspan was partly responsible for.

by B-Rocker | 7th Oct 21, 11:30am 1633559458

What is the difference between our existing currency, the dollar, which is mostly traded digitally except for a small proportion in physical notes and coins, and a separate currency created that is 100% traded digitally with no physical notes and coins? If the separate currency's supply is to be managed by the RBNZ in the same way as the dollar is currently.

by Pacman_46 | 7th Oct 21, 11:39am 1633559963

Exactly. Issuance is the issue. The world needs a decentralised, mathematically-fixed issuance, open-source, cyrptographically-secure bearer asset for instant and final international settlement (with no counter party risk) in a global online marketplace. The scarce resources that remain in the world need to be valued with a system designed with digital scarcity. Anything else is just the same shit, different wrapper.

by ShoreThing | 7th Oct 21, 11:40am 1633560008

The difference is that this technology allows Central Banks and Governments to be extremely creative with new policies to control the economy. They could introduce some kind of a decay function, akin to negative interest rates, so if you don't spend your tokens they disappear over time - forcing you to spend the money or lose it. A well-meaning government could decide that any number of goods and services are unsavoury, and restrict or prohibit entirely their purchase. The opportunities are vast, and it seems from the whitepapers being produced by Central Banks and think tanks that they mean to design this technology to at least be capable of all these things and more.

by B-Rocker | 7th Oct 21, 12:05pm 1633561541

Thanks ShoreThing. So it specifically relates to the technology. I understand (form a high level) the decay function capability. I don't understand how this technology can know what goods and services are being traded?

I also don't understand: 1) Whether this technology can just be 'applied' to the dollar without creating a separate currency; and 2) How this affects private banks, i.e. what is the difference if banks issue dollar debt or 'new currency' debt.

by ShoreThing | 7th Oct 21, 12:28pm 1633562910

Any business with an IRD number has already had to provide a BIC identifying the type of business they are involved in, so the systems we have in place today can already be used to identify broad industry categories. The government could decide that problem gambling is harmful to our communities, and restrict wallets to only spending $50 per week at any other wallet registered with IRD as a gambling institution, as an example. Potentially these systems could be refined even further, down to an item level - like a different allowance for domestic beer than imported beer, or something.

From what I've read of the Central Banks discussion papers, this would effectively replace the dollar by gradually phasing out all physical currency. There wouldn't be a new currency. How this affects private banks is an area of debate.

by LASSET | 7th Oct 21, 11:43am 1633560200

And that's the crux, looking at the bigger picture there is no difference in monetary policy or its overall effects. You need to look to BTC for that.

But a CBDC does give the central bank more direct control over a lot of things as mentioned by shorething above. Without getting into the possible privacy and liberty concerns, from a basic view it also effectively cuts out all the middlemen in the system that are involved with the movement of money between entities and countries (Saving significant time and cost).

by Carlos67 | 7th Oct 21, 11:44am 1633560277

Just about to type exactly the same thing. We already have a digital currency all that needs to happen now is to stop wasting money printing cash and coins and the jobs done. The problem is that cash is used far more extensively than many people believe and it would not be a popular decision to pull it from circulation. The process of removal from the system is no different from removing old notes like the $1 and $2 we had years ago and small denominations of coins you simply take it into the bank and your Eftpos card gets a higher balance. You set a time limit after which time the physical cash is worthless and is no longer legal tender and the jobs done.

by Nzdano | 7th Oct 21, 12:58pm 1633564706

I guess it means that we wouldn't need the banks, we could effectively have a direct account with RBNZ

by Roy1 | 7th Oct 21, 11:38am 1633559922

How to protect bank...

Will be great if rserve bank are first able to protect themselves.

Like everything banking system will change with many BNPL companies entering and evolving themselves to tech giants moving in that space.

Digital currency is to protect reserve bank first than anything else.

by Brock Landers | 7th Oct 21, 11:54am 1633560843

Nobody in their right mind would entrust their savings to the criminal central bankers.

by Carlos67 | 7th Oct 21, 12:24pm 1633562697

I'm beginning to see why your struggling in the real world Brock.

by Brock Landers | 7th Oct 21, 12:48pm 1633564096

Would you like to elaborate on that or are you just rambling senile nonsense with spelling mistakes?

by powerdownkiwi | 7th Oct 21, 12:25pm 1633562718

Savings? Nobody in their right mind should still be calling accumulated digits 'savings'.

https://assets.publishing.service.gov.uk/government/uploads/system/uplo…

You can read it over lunch.

Then ask what 'savings' represent?

by SailorRob | 8th Oct 21, 2:46pm 1633657595

That's just the Communist manifesto...

Productivity is getting more from less, all you're doing is losing with these crazy theories.

by treadlightly | 7th Oct 21, 12:39pm 1633563554

Our savings already reside within the Reserve Bank in the form of bank reserves which the banks use to lend to one another or to settle their inter bank payments.

by ShoreThing | 7th Oct 21, 12:49pm 1633564173

Yours might, but not everyones.

by treadlightly | 7th Oct 21, 1:58pm 1633568336

If they are savings in the form of NZ Dollar currency that is where they will be unless they are in cash.

by ToTheMoon | 9th Oct 21, 8:38am 1633721931

Trust ones value to a group of unelected bankers who are addicted to debasing currency or currency that is mathematically proven to be the most scare thing in existence. The choice is obvious.

by rastus1 | 7th Oct 21, 12:50pm 1633564258

Digital currencies are coming.

In what form is the question. Just as the likes of google, FB etc lept ahead from the crowd, so will a digital currency. Might be US Fed, Yuan or gold backed.

What is amusing is that the BTC etc fans think they have already discovered who wins.

Time will tell.

by Brock Landers | 7th Oct 21, 1:14pm 1633565667

With the central bank digital currencies its all about them having infinite control over what, where, why and how and when you use your money.

Take a look at what China is doing in this space. No thanks.

by frazz | 7th Oct 21, 1:19pm 1633565942

What more amusing is the BTC bears who think we will all just accept a gold backed CDCD with no total cap? What's the attraction?

by LASSET | 7th Oct 21, 1:38pm 1633567095

You're right, time will tell. But BTC is the most sound 'money' the world has ever seen, probably the hardest currency ever created. And there cannot be another immaculate conception. I'm pretty confident on what that will mean long term.

by rastus1 | 7th Oct 21, 2:18pm 1633569492

Spare me. Save it for a Destiny Church sermon. Just like religion there are thousands of crypto's and the followers are cut from the same cloth.

by LASSET | 7th Oct 21, 2:40pm 1633570812

Nothing is certain in life, but there's few things I'm more confident about than this. I've put my money where my mouth is. Exactly what the end game is I don't know, but BTC is not going away, and there is no competition.

by rastus1 | 7th Oct 21, 3:21pm 1633573272

Nothing is certain in life, but there's few things I'm more confident about than this. I've put my money where my mouth is. Exactly what the end game is I don't know, but the Destiny Church is not going away, and there is no competition.

by LASSET | 7th Oct 21, 4:08pm 1633576089

LOL!

by J.C. | 7th Oct 21, 6:02pm 1633582974

Nothing is certain in life, but there's few things I'm more confident about than this

Lassie, it's quite possible I've joined the ultra-orthodox cult too. I've not fully converted but close.

by frazz | 7th Oct 21, 4:48pm 1633578538

"Spare me"...yup we have all moved on from your ramblings

by colinchch | 7th Oct 21, 1:15pm 1633565759

Yes this is fraught with major problems and potentially crossing the rubicon in terms of money creating leading to a inflationary disaster and a major loss of financial privacy not to mention political interference in the cookie jar.

https://www.fxempire.com/forecasts/article/everything-you-need-to-know-…

Potential for inflation

Central Bank Digital Currencies allow for limitless money creation in the truest sense. By removing the constrains of the banking sector, central banks can decide to increase the CBDC deposits on any or all individuals at their discretion, as I have discussed. The constraints on this ability of true money creation will ultimately befall to the inflationary repercussions.

In a recent podcast with Grant Williams conversing with the great Lacy Hunt, Lacy opined the following in regard to the potential introduction of CBDCs: “If a government digital currency is enforced, the government would be able to track and control everyone’s financial record, it would be a great intrusion on private freedom. A US CBDC would put the Fed in the money printing business and constitute a major break within out system.

Money would have no value as soon as the money illusion passed and Gresham’s Law would prevail. CBDCs are part of the view that financial transactions create income and wealth, not hard work, creativity and saving out of income, they would be a trump of the free lunch school of economics. The US at that point will have achieved banana republic status. To go along this path would lead to hyperinflation and widespread miserable conditions for the US household.”

by Zack Brando | 7th Oct 21, 1:36pm 1633566989

Well, the same panic would be happening if gold way skyrocketing. Banks and Governments should have managed their economies better.

by Squishy | 7th Oct 21, 3:49pm 1633574984

I favour decentralised currencies that can't be inflated or transactions restricted.

by Jonny.Foe | 7th Oct 21, 5:56pm 1633582618

Digital currencies are the latest nail in the coffin of commercial banks. Commercial banks now play no useful role. The technology required to run basic bank accounts, mortgages, payments etc (all that most of us need) is simple, almost completely automated, and cheap to run. So, why exactly do we allow banks to make billions of dollars from us every year? Why does the Reserve Bank pay commercial banks 0.5% interest on their deposit (reserve) accounts? If the Reserve Bank offered a basic bank account (paying 0.25% interest on credit to save money!) with all balances guaranteed by the Government, they would clean up.

by smian711 | 8th Oct 21, 7:57am 1633633037

The number of comments on this post should tell you something!

Note, Stablecoins already exist and back hundreds of billions of dollars. USDC, USDT, DAI etc.

They need to adapt or get left behind. People are already transacting in privately issued currencies.

Another point of discussion is the matter of security and decentralisation. Where will the computers be stored that secure the RBNZ coin?

Come on RBNZ - come build your stablecoin on the Ethereum network.

by glimmertwin | 8th Oct 21, 11:04am 1633644284

Haha,,the ‘crypto crowd’.

You lost me there.Bitcoin is an

unstoppable decentralised freight train.Ignore it at your peril.

by SailorRob | 8th Oct 21, 12:31pm 1633649491

How would people remove money from NZ bank accounts? For each purchase of a digital currency there would have to be a seller who accepts the bank account money. Only way it could be removed is it it was destroyed by some entity.

by ToTheMoon | 9th Oct 21, 8:33am 1633721632

What would be the reaction? Could the authorities simply start making private issued digital coins illegal?

Crypto is not private. The public can choose to participate in its development, transfer, validation and minting, unlike central bank fiat which is, by comparison, private.