At some point in 2009, former chairman of the U.S. Federal Reserve, Paul Volcker said that “the ATM has been the only useful innovation in banking for the past 20 years”. With his passing in December 2019, it seems Volcker may have missed the seemingly unstoppable adoption of digital currencies. Even Her Majesty’s Treasury (and the Bank of England) have made moves to join the fray with the April 2021 announcement of the formation of a task force to explore a Central Bank Digital Currency (CBDC). Before delving into the proposal and its ramifications, it’s important to define terms.
To be sure, a CBDC is not a cryptocurrency like Bitcoin or Ethereum. The fundamental difference is that cryptocurrencies are decentralized and lack an issuing authority, while the theoretical Digital Sterling would be issued and controlled by the Bank of England. Likewise, the anonymity granted to cryptocurrency holders does not extend to digital currency. Unlike crypto, according to the Bank of England, the Digital Sterling would not utilize distributed ledger technology, often referred to as the Blockchain. Finally, unlike Stablecoins – cryptocurrencies are pegged to another asset (often a currency) – the Digital Sterling would be actual Sterling.
With that background, the obvious question is “why?”. If people are already going “cashless” and accessing their banks digitally, and central banks use electronic systems to keep the entire banking system running what is the need for a national digital currency. Why do this and why do it now?
Governments are in a position of needing to play catch up. Unregulated crypto is gaining traction so governments need to issue a digital asset so they can both transact digitally and still regulate monetary policy. The additional reality that current banking is vulnerable to nefarious hacks, while as far as we know the Bitcoin blockchain has never been hacked – that is not to say that there have been no hacks of the applications that provide an interface to the blockchains – but the actual distributed ledger technology is safe. The security of the blockchain is one of the reasons so many applications are being proposed for it, from welfare payments to medical and criminal records.
Blockchains offer four primary benefits:
Because of this, we’re likely to see ever-increasing adoption of distributed ledger technology. Yet, CBDC won’t be using a distributed ledger. If a Blockchain is not being used, what is really being introduced?
The Economist notes that the least noticed “disruption on the frontier between technology and finance” could be the creation of government digital currencies allowing people to deposit funds directly to a central bank rather than the current system. So, the first advantage to a CBDC is the democratization of finance, shifting power towards individuals. Do people bypass banks altogether and just bank with the central government? Meaning are the intermediaries who charge fees and have less-than-stellar customer service going to serve a purpose in a CBDC world?
This leads to an extremely important advantage to digital currency – the ability to reach the currently under and un-banked. Both models, digital and crypto have great promise to bank the underbanked, particularly in undeveloped countries thanks to the spread of smartphones and the way they function as proof of identity. With a 42 percent market penetration rate in India, it is extremely possible that more people have smartphones than have driver’s licenses. Digital wallets via a mobile device are the essential building block to crypto the same way broadband was to the Internet. Over time this scalability and saturation will decrease price volatility and increase security.
Of course, it’s also possible that central banks are freaking out over what could prove to be a passing fad. In other words, are central bankers trying to learn the Macarena or figure out how to get a profile on TikTok? While current trends and investment focus suggest crypto is here to stay and China pressing ahead with CBDC suggests that to be competitive in the global market, a central bank has to have a CBDC, it’s impossible to truly know the impact – like trying to determine the impact credit cards would have if they were just being introduced.
The signs all point towards the likelihood of cryptocurrency becoming more widely used, and for some mainstays to become more stable. With China pushing ahead with its plans and the BoE and other central banks starting their own processes, it would be hard to say that crypto and digital currency are not here to stay. With that in mind, entirely new regulations, oversight, and enforcement should be expected as well. It is incumbent on financial institutions to try and read the tea leaves and speak to external advisors to begin to plan for potential regulations and their impact.
Your local bank branch or the interminable wait to speak to a customer service representative are not going anywhere tomorrow, but in the near future, we could see a drastic overhaul of the global banking system as it becomes more democratized and disintermediated, while at the same time reaching more people and offering more security. Central banks are playing catch up as they desperately seek out ways to remain relevant and essential. While cryptocurrency likely has no more than 5 percent of the global money supply, it is not hard to see why central banks all over the world are scrambling to develop digital currency options.
At Vox, we regularly help financial institutions to manage the complexity of change, be it Regulatory, Digital Transformation, or Data related. If you need help, get in touch with Phil Marsden at firstname.lastname@example.org or visit www.voxfp.com to learn more.