A Central Bank Cryptocurrency? Not in 2018

JP Koning is an avid blogger covering monetary economics and the history of money on his blog Moneyness. 

The following article is an exclusive contribution to CoinDesk’s 2017 in Review.

Central banks may be the 800-pound gorillas of the financial universe, but they have largely kept their hands off of bitcoin and other cryptocurrencies, preferring to monitor developments from a distance.

Will that change in 2018?

Some have speculated that 2018 will be the year that central banks start to add bitcoins to their balance sheets. I don’t think so. Here’s why: Your average bitcoin buyer has dramatically different goals from your average central banker.

Bitcoin buyers want to earn 10,000 percent returns and engage in near-anonymous transactions. Central bankers don’t need high returns, nor do they require anonymity. They have an obligation to their citizens to ensure the stability of the currency. The steadiness of the assets that central banks hold in their portfolios is a key part of achieving this mandate.

If the purchasing power of money begins to fall too fast relative to its target, central bankers will try to undo this by buying back sufficient amounts of currency. This requires selling assets from their portfolio, or open market sales.

Assets that do not fluctuate much in value – say a government bond – can be counted on as steady material for open market sales. But bitcoin’s price regularly fluctuates by 20-30 percent per week. Given this volatility, a central banker can’t expect to rely on bitcoin to provide oomph in future buyback efforts.

This means bitcoins won’t help central bankers achieve their price stability mandate, and I wouldn’t expect any of them to begin including bitcoin and other cryptocurrencies in their portfolios.

Now, there may be a few central banks that add trace amounts of cryptocurrencies to their balance sheets – but only as a political stunt. For instance, I can imagine the Central Bank of Iran or the Central Bank of Russia publicly announcing that they’ll reduce their U.S. dollar reserves by some small amount and substituting it with bitcoins.

But this would only be a way to land a public relations blow against an enemy, and not as a way to promote sound central banking.

Central bank digital currency

Many central bankers have been exploring the idea of issuing central bank digital currencies or digital accounts for use by regular folks. These tokens could be issued on a blockchain, held in a regular account, or exist on a smart card. Unlike bitcoin, this form of money would be fixed in value – i.e. one unit of digital currency would be pegged at $1 banknote.

I think it is unlikely that any central bank digital currencies or accounts will be introduced in 2018. There is a good chance that many central banks will even backpedal their efforts as they learn more about the challenges involved in introducing a digital payments product.

Here is the crux of the problem: It only makes sense for a central bank to issue digital currency or publicly-available accounts if there is sufficient demand. But it is not apparent where this demand will come from given that private bank accounts already provide the public with the same set of services that a central bank product would hypothetically offer.

For instance, one stated advantage of a central bank digital currency is that citizens would get the ability to hold risk-free digital money. But since bank deposits are themselves guaranteed by state-run insurance deposit schemes up to very high amounts, they are already 100 percent safe. So there is no apparent reason for anyone to switch.

Nor will central banks find it easy to compete with already-existing private sector payments alternatives.

Would the People’s Bank of China (PBOC) do a better job running a retail payments network than Alibaba or Tencent? Would the Bank of Canada provide a superior payments product than Canada’s commercial banks, say TD or CIBC, which bundle all sorts of other financial services along with their payments offering? Probably not.

So, it is not apparent to me why the public would want to use the central bank’s product – and thus no reason for central bankers to spend much time on these projects.

A central bank digital currency could only gain public acceptance by providing a unique service that private alternatives do not offer: anonymity. We already know people use physical cash because – among other reasons – it enhances privacy. Likewise, anonymity would drive adoption of a digital version of cash. But, this would force central bankers out of their comfort zone and into what would be a contentious public debate over anonymity and financial censorship.

The upshot is that the only digital currency projects that stand a chance of surviving against the private competition must include anonymity, but only determined central bankers who understand the value of anonymity as a public service will be able to drive these anonymous digital currency projects forward in the face of criticism.

Unfortunately, there probably aren’t too many central bankers out there willing to take that risk.

Regulation

Still, with central banks hesitant to buy cryptocurrencies or adopt CBDC, the one front on which they will be active in 2018 is regulation. As cryptocurrencies become ever more embedded into the conventional financial sector – say through futures, ETFs, hedge funds, or credit to buy bitcoin – the perceived risks of instability spreading from cryptocurrency markets into conventional markets increase.

Central bankers have stood by through most of the rise of cryptocurrencies. But since they have a watchdog role to play, I would expect them to increasingly view it as their responsibility to step in and regulate the sector.

It remains to be seen what form this regulation takes.

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Federal Reserve building via Shutterstock

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