At Davos last week, the World Economic Forum released a 28-page article on central bank digital currencies (CBDCs). The document is intended to help countries to introduce digital currencies. An insight from Demelza Hays.
The World Economic Forum’s Central Bank Digital Currency Policy‑Maker Toolkit is a document that explains design features of CBDCs including, potential benefits, risks, and costs of implementation.
Design characteristics of the "CBDC Policy-Maker Toolkit"
The overall message in the WEF’s CBDC Policy-Maker Toolkit is clear: CBDCs will not be a harbinger of freedom and prosperity based on sound money principles. The most glaring red flags are the following:
- First, central bank CBDCs are not intended to be public and permissionless cryptocurrencies.
- Second, even if a central bank decides to release a public and permissionless cryptocurrency, regulators will only allow its use for small transactions similar to fiat cash.
- Third, the supply of CBDCs will not be controlled by an algorithm and, hence, mathematically limited in supply. Rather, the central bank will have full control of the CBDC.
- Fourth, central banks may need to increase their balance sheets (i. e. inflate the existing money supply) if they decide to issue so-called “retail” CBDCs. Retail CBDCs allow individuals and non-financial intermediaries to have direct deposit accounts at the central bank, which in turn will reduce the ability for banks to increase the money supply via the money multiplier.
- Fifth, CBDCs will be fiat and, therefore, not convertible.
Centralised systems preferred with the CBDC Policy-Maker Toolkit
Regarding the first point that central bank CBDCs are not intended to be public and permissionless cryptocurrencies, the paper states that “DLT-based CBDC would operate best within a closed ‘permissioned’ network of pre‑identified validating parties” and that “regulators or other institutions could participate as additional validating nodes or observer nodes where they could have validating or view privileges.” Translation of the 1984 Newspeak: CBDCs will neither be public, meaning that anyone can view the transactions in the ledger, nor permissionless, meaning that anyone can write transactions into the ledger. The authors also point out the central bank will be able to veto i.e. censor any transaction. The CBDCs will actually allow central banks to have even more surveillance of transactions than currently, where the two-tiered central and commercial banking system involves anonymous physical cash and bearer share securities.
Free use of CBDC's only for small amounts
Regarding the second point that a truly public and permissionless CBDC should only be permitted for small transactions, the paper states that “a universally accessible CBDC without identity requirements would increase the risk that the CBDC could be used for illicit activity and also conflict with most know‑your‑customer (KYC), anti‑money laundering (AML) and countering the financing of terrorism (CFT) requirements.” This means that the War on Cash will become a War on CBDCs for any CBDCs that resemble Bitcoin’s pseudonymous nature.
Regarding the third point that the supply will not be limited, the authors clearly state, “the central bank would fully control the issuance of CBDC, as it does with a centralized system.”
Choice of counterparty risk is at the expense of commercial banks
Regarding the fourth point that central banks will need to preemptively increase the money supply before issuing a retail CBDC, the authors point out, “The substitution of deposits for CBDC might also have dampening effects on the money multiplier process.” What this means is that if individuals can choose between having bank accounts at banks that represent a counter party risk with the bank directly and then with the central bank indirectly or having a bank account directly at the central bank, they will choose the latter, because there is one less counterparty involved.
If individuals no longer deposit money in commercial banks, how will banks create money out of thin air via the money multiplier and “guarantee a sufficient supply of liquidity to the economy”? Basically, this entire part of the paper is asking, how would a functioning economy survive without persistent degradation of household savings?
Regarding the fifth point that CBDCs will be fiat and not convertible for real assets, the authors write, “Token‑based retail or wholesale CBDC is said to be held by the owner in digital wallets of various kinds and, like physical cash, represents a “token” or object of stored value that is digital fiat money…” and “The public could have accounts of the digitized fiat currency with the central bank, or hold CBDC on mobile devices, prepaid cards or other forms of digital wallets.” Therefore, CBDCs will not be convertible for real assets like gold. Similarly to the current system, the quantity and the quality of the assets held by the central bank on their balance sheet will cause fluctuations in the the exchange rate of the CBDC with other CBDCs.
No need for traditional correspondent banks with international payments
Despite the clearly pro-government-issued money bias, the authors do bring up some good points, if reading between the lines. For example, the authors pose an important question with regard to retail CBDCs, namely, why is it that individuals are not allowed to have bank accounts at the central bank in the current monetary system? Currently, specific banks, called correspond banks, are allowed to have accounts at central banks, and all other banks, called respondent banks, must interact with correspondent banks. Individuals are at the bottom of the food chain paying transaction fees to a host of intermediaries.
Due to the digital nature of CBDCs, the authors argue that sending money overseas will have lower transaction costs stemming from the complex web of respondent and correspondent banks that currently handle foreign exchange transactions. However, the authors also previously pointed out that wholesale CBDCs are equivalent to the current two-tiered monetary system that is currently in place.
In order to reduce the complexity of the current system, the paper proposes to allow foreign entities to directly hold CBDCs. This is very interesting in terms of geopolitics, because any entrepreneurial central bank could create a convertible (non-fiat) CBDC backed by real assets and then sell that CBDC to the world. This would spark a global competition of CBDCs with very low switching costs. Countries with CBDCs based on sound money would attract capital instantly, and the exchange rate would appreciate and CBDCs based on modern monetary theory would lose capital instantly.
CBDCs as direct liabilities of central banks
Another interesting point that the authors make is that CBDCs are liabilities of the central bank. Central banks can issue CBDCs as new liabilities by increasing their asset side with bonds or by taking part of their existing liabilities, such as physical bash or commercial bank reserves and converting them into CBDCs. Hopefully, central banks will do the latter in order to preserve purchasing power of the money in circulation.
The authors of the "CBDC Policy-Maker Toolkit" successfully clear up the confusion surrounding definitions and about what blockchain can and cannot do. They rightly point out that wholesale domestic CBDCs are the same as how the two-tier banking system. This system currently works where registered banks are able to store reserves at the central bank, and then those banks are able to issue their own liabilities to bank depositors. The authors also explain that the much touted benefit of instant settlement is not a feature of distributed ledger technologies, but rather a feature of conditional programming and general‑purpose hash functions. The “hopium,” or hope-filled opium, around securities platforms being able to reduce security settlement from three days to instantaneous is not a feature unique to blockchain databases.
More competition in the currency market
As a final remark, the authors do write many times that CBDCs do increase competition in the currency market. Although the authors mainly mean that retail CBDCs will compete with commercial banks like UBS and payment processors like Worldline and SIX, CBDCs will also have to compete with cryptocurrencies like Bitcoin, decentralized stablecoins like MakerDao Sai, and privately issued monies like Facebook’s Libra. Central banks are on the brink of facing a very tough decision between continuing to appease political whims with cheap money or become extinct.
In conclusion, CBDCs are nothing more than the emperor’s new, albeit invisible, clothes.
"But he has nothing on!" said the whole people at length. That touched the Emperor, for it seemed to him that they were right; but he thought within himself, ‘I must go through with the procession.’ And so he held himself a little higher, and the chamberlains held on tighter than ever, and carried the train which did not exist at all. - Hans Christian Andersen, 1837