In conjunction with IBM, the Official Monetary and Financial Institutions Forum (OMFIF) released a report including a survey about Central Bank Digital Currencies (CBDC). While it reiterates the wide-spread reservations about retail CBDCs, the paper focused purely on a wholesale or institutional CBDC which it says is “certain to be implemented in the future”.
The OMFIF is an independent think tank for central banking with members from central banks, sovereign funds, public pension funds, and financial institutions.
The report highlights the tension between trying to reimagine new systems that distributed ledger technologies (DLT) enable, versus trying to use the latest technology with existing models and processes.
Why do we need CBDCs?
Before delving into the report, it’s worth asking why CBDCs are needed? In the cryptocurrency world, there’s an increasingly wide choice of stable coins. Once enterprise blockchain becomes more widespread, companies will want to settle contracts on-chain. They want something more trustworthy than stable coins, especially institutions trading equities, bonds, derivatives and other instruments.
These markets total almost $800 trillion compared to $0.2 trillion for the cryptocurrency sector.
Talking at the Deconomy conference earlier this year, Stanley Yong, Head of CBDC for IBM spoke about the need for CBDCs (he stressed his statements were his own not IBM’s). He discussed the issue where ownership of an asset and payment could exchange simultaneously, commonly referred to as delivery versus payment. This contrasts with the risk involved in waiting for a payment to clear.
“For your smart contract to deal with deterministically, atomically with swaps and fulfill all the promises of smart contracts, we need to have assets that are really fully on-chain,” said Yong.
“And that’s why, back to tokenization again, we are trying to tokenize all these assets including CBDC. Because Central Banks don’t need a CBDC. The truth is the crypto-economy needs CBDC.”
And he explained that central banks are resistant. “There’s no way you can persuade a central bank to issue a CBDC on its own merits. You have to go to a central bank and say: ‘I want you to help me issue a CBDC because there are all these benefits that come from using smart contracts for XYZ use cases.'”
Reinforcing this, OMFIF found that 61% of central banks said blockchain might not be necessary as they have observed few efficiency gains during trials.
IBM has been low-key with CBDCs, compared to other blockchain areas such as their involvement with CLS and their launch of World Wire for payments. Jesse Lund, VP of IBM Blockchain, says in the report: “Beginning with wholesale CBDCs that optimize interbank settlement, as well as settlement between central banks, IBM has already deployed pilot networks with marked success.”
He continued: “There are still many details to sort out, but cryptocurrencies are here to stay, and so we endeavour to apply the same benefits to fiat currency issuance without sacrificing traditional monetary policy, enhanced due diligence, and other compliance controls.”
There have been several publications from the BIS and central banks conducting experiments such as Canada’s Project Jasper and the Monetary Authority of Singapore‘s work. This OMFIF report summarizes many of the results and also incorporates responses from 21 central banks surveyed between July and September 2018. Of those banks, 38% of interviewees are researching and trialing wholesale CBDCs.
One of the survey questions was whether central banks should design a CBDC in partnership with the private sector. 50% responded positively, saying stakeholders need to be involved.
Most survey respondents believe the central bank should issue a wholesale CBDC. The report refers to the UBS’s Utility Settlement Coin (USC) project as a wholesale CBDC, but one which only involves central banks as custodians. The USC is like a stable coin, except the money that provides the one-to-one backing is deposited at central banks by commercial banks. The OMFIF noted that with CBDCs most central banks focus on their Real-time Gross Settlement Systems (RTGS) rather than acting as custodian.
Other survey highlights:
- 76% state that it is uncertain whether DLT will be able to deliver on its promise, especially in areas such as regulation.
- 69% of survey respondents found significant issues with the current cross-border processes.
- Of respondents not considering a wholesale CBDC, the majority state the current technology may not be mature enough to serve as core infrastructure.
- 69% said resiliency had become an increasing priority for central banks.
- Around 8% of survey respondents explicitly stressed that a wholesale CBDC would have an impact on monetary policy.
- Almost half of the respondents claimed individual participants should host servers, while the remainder insisted that central banks should store the servers.
The report states that it may not be necessary to apply blockchain since central banks as ledger keepers are considered sufficiently trustworthy already. However, on the flipside, DLT could result in greater efficiency, speed, and resilience.
That might be achieved by reducing the complexity involved with current systems. The complexity is in part the result of layering multiple technologies on top of real-time gross settlement systems. And current systems are also prone to technical faults.
Mechanics and monetary policy
A CBDC would involve several policy changes. Operating hours may need to be extended. There may need to be new member types to enable access to wholesale CBDC. For example, project Jasper had to do workarounds so that brokers could access CBDC.
Limited central bank operating hours could be addressed by setting up secondary markets for token-based interbank currencies.
Old versus new
The report highlights the conflict between old and new. The stability of economies are dependant on RTGS systems, so central bankers need to be risk averse.
For example, the report states that the central bank’s DLT experiments produced mixed results because researchers focused on novel avenues. At the same time, none of the central bank case studies looked at radically overhauling their payment systems. Most central banks are satisfied with existing RTGS systems.
A key finding was: “The challenge that remains for the main vendors of wholesale CBDC systems is to construct a convincing RTGS replacement that can be properly benchmarked against existing systems and meet the high standards for security, robustness, efficiency and speed.”