Wednesday, September 20, 2017

BIS - Central Bank Cryptocurrencies

This BIS has issued a new report on possible uses for cryptocurrencies by central banks. This is really where the focus is at this time in terms of something that could impact the current monetary system. Below are a few excerpts from the BIS report and then some added comments.
"In less than a decade, bitcoin has gone from being an obscure curiosity to a household name. Its value has risen - with ups and downs - from a few cents per coin to over $4,000. In the meantime, hundreds of other cryptocurrencies - equalling bitcoin in market value - have emerged (Graph 1, left-hand panel). While it seems unlikely that bitcoin or its sisters will displace sovereign currencies, they have demonstrated the viability of the underlying blockchain or distributed ledger technology (DLT). Venture capitalists and financial institutions are investing heavily in DLT projects that seek to provide new financial services as well as deliver old ones more efficiently. Bloggers, central bankers and academics are predicting transformative or disruptive implications for payments, banks and the financial system at large.

Lately, central banks have entered the fray, with several announcing that they are exploring or experimenting with DLT, and the prospect of central bank crypto- or digital currencies is attracting considerable attention. But making sense of all this is difficult. There is confusion over what these new currencies are, and discussions often occur without a common understanding of what is actually being proposed. This feature seeks to provide some clarity by answering a deceptively simple question: what are central bank cryptocurrencies (CBCCs)?

To that end, we present a taxonomy of money that is based on four key properties: issuer (central bank or other); form (electronic or physical); accessibility (universal or limited); and transfer mechanism (centralised or decentralised). The taxonomy defines a CBCC as an electronic form of central bank money that can be exchanged in a decentralised manner known as peer-to-peer, meaning that transactions occur directly between the payer and the payee without the need for a central intermediary.3 This distinguishes CBCCs from other existing forms of electronic central bank money, such as reserves, which are exchanged in a centralised fashion across accounts at the central bank. Moreover, the taxonomy distinguishes between two possible forms of CBCC: a widely available, consumer-facing payment instrument targeted at retail transactions; and a restricted-access, digital settlement token for wholesale payment applications."

. . . . .

Retail central bank cryptocurrencies

"Retail CBCCs do not exist anywhere. However, the concept of a retail CBCC has been widely discussed by bloggers, central bankers and academics. Perhaps the most frequently discussed proposal is Fedcoin (Koning (2014, 2016), Motamedi (2014)).11 As discussed in Box B, the idea is for the Federal Reserve to create a cryptocurrency that is similar to bitcoin. However, unlike with bitcoin, only the Federal Reserve would be able to create Fedcoins and there would be one-for-one convertibility with cash and reserves. Fedcoins would only be created (destroyed) if an equivalent amount of cash or reserves were destroyed (created) at the same time. Like cash, Fedcoin would be decentralised in transaction and centralised in supply. Sveriges Riksbank, with its eKrona project, appears to have gone furthest in thinking about the potential issuance of a retail CBCC (Box C).
A retail CBCC along the lines of Fedcoin would eliminate the high price volatility that is common to cryptocurrencies (Graph 1, centre panel).12Moreover, as Koning (2014) notes, Fedcoin has the potential to relieve the zero lower bound constraint on monetary policy. As with other electronic forms of central bank money, it is technically possible to pay interest on a DLT-based CBCC. If a retail CBCC were to completely replace cash, it would no longer be possible for depositors to avoid negative interest rates and still hold central bank money.
Any decision to implement a retail CBCC would have to balance potential benefits against potential risks. Bank runs might occur more quickly if the public were able to easily convert commercial bank money into risk-free central bank liabilities (Tolle (2016)). There could also be risks to the business models of commercial banks. Banks might be disintermediated, and hence less able to perform essential economic functions, such as monitoring borrowers, if consumers decided to forgo commercial bank deposits in favour of retail CBCCs."
My added comments: If you are wanting to learn more about all this, you may find this report pretty informative. It does a good job of explaining what can be a somewhat complex topic. We have pretty much covered the basics of what is talked about in this report here for some time. A long time ago we were talking about the concept of being able to access money on a mobile phone in real time and send funds around the world at very low cost, etc. We have talked about individual central banks looking at new technology for some time as well. So the section of this report that talks about that idea is nothing surprising here. 
At this point the big issues going into the future will more likely be just what various central banks actually decide to do first of all. The decisions they make will then provoke some kind of public reaction (favorable or unfavorable) depending on what they decide to do. Since so many variables are still possible I view it as premature to try and speculate what most central banks will end up doing.
Here are a few key points I think I can make with confidence based on direct input I get from very high credibility sources:
- all this will take some time to develop and most likely will come along in stages unless some kind of new major financial crisis creates a sense of urgency to move faster that does not appear to exist today. Global consensus and political will is very low at this time.
- I think the most likely thing we would see first are a few central banks issuing electronic forms of their existing currency using what they will call "blockchain" technology as the ledger system to record transactions. I think Singapore is a good place to watch for something like that to show up.
- there is no indication at this time that either the IMF or the BIS is close to using any kind of blockchain based new version of the SDR (at least not the official SDR). I might expect instead to see the IMF looking closely at promoting the use of the private SDR more by the middle of next year after reviewing a study along those lines. The private SDR would not be backed by anything. It would simply be valued based on the existing basket of five currencies used now to value the official SDR. I look at the private SDR as just simply holding a combination of the five currencies that make up the basket in the ratio used for that basket and not really much more than that. More like using the name SDR to describe how the instrument owned is denominated and certainly not owning any actual official SDRs. I don't view that as anything that is a major change to existing monetary system. 
- I do not think any final decisions have been made as to whether to even use central bank digital currencies at many central banks at this time. When the first few roll out the concept (perhaps by early next year), I would expect others to watch closely how well that is received by the public and how well it works in the real world. I do not expect "digital currencies" to eliminate the use of physical cash any time soon in most parts of the world including the US.
- I do not believe there are any plans to restrict ownership of gold or silver coins (of any kind) by central banks, the IMF, or the BIS at this time. If something happened to send the price of gold and silver sky rocketing higher, it would not shock me to seem them impose some kind of "windfall profits" tax on unusually high gains in some countries. But I don't know that any plans to do even that exist currently.
- I do not think we are close to ANY kind of new global reserve currency that would replace the US dollar very soon. The only thing I can see that might speed up that process would be a crisis or war significant enough to disrupt the existing monetary system. I should add that Jim Rickards is now on the record with a public interview predicting that war with North Korea will be such an event and will happen within the next 8 months (more details on this coming Friday).
Summary: Based on the best information I have at this time, readers should follow the situation with North Korea closely. That seems like the most likely trigger event to bring about a potential crisis that could then lead to some bigger changes in the monetary system.
If no crisis does emerge, the most likely scenario that I am aware of is for some central banks to slowly but surely stick their toes into the central bank digital currency waters, perhaps starting in Singapore working with some major private partners. If a dozen or more other central banks follow along, we can expect that central banks around the world, the IMF, and the BIS will watch closely to see how things work out for them (sort of like trial runs). I would be surprised if these first steps are completed before at least the middle to the end of next year based on current information. We might see the process start up this fall. The public reaction to these steps will probably depend on exactly what individual central banks decide to do in various countries. The major issues will probably be what happens to cash and whether the ability to maintain privacy in monetary transactions is preserved. 


  1. "If a retail CBCC were to completely replace cash, it would no longer be possible for depositors to avoid negative interest rates and still hold central bank money." This sentence caught my eye, and why I don't think CBCC will ever completely replace paper.

  2. The best information I have at this time is that there are no plans to try to get rid of cash any time soon. Instead, what I think is more likely is that the use of cash will continue to diminish on its own just because people like the convenience of online and mobile money payments and apps etc. As the younger generation becomes a higher % of the population, more people will prefer this kind of thing instead of using cash I believe. They have grown up that way using their phones for everything. What would be interesting is what they would do if the system collapses and those forms of money payments don't function properly. Not sure if many would know what to do these days.

    1. I think that is a good point. Today's youth don't seem to care as much about privacy and anonymity because the post on Facebook, Twitter, Snap, and all other social media constantly. So as the author of the paper says, if anonymity is not desired, public accounts at the central bank could provide the digital function without distributed cryptocurrencies.

      Exactly. This is my thinking. Why bother imposing something on people when they are happy to accept it on their own anyway.
      I think you nailed it with those comments. My generation (older) is less that way, but every year there are less of us and more younger people making up the general public. Those in the younger generation who don't trust central banks are into Bitcoin etc. But they are a tiny % of the public so far. If Bitcoin (and other cryptos) were to become a real threat, then I would expect central banks and governments to get more involved in trying to regulate it and control it. I agree that this is why central banks are questioning the need for some kind of token version of their existing currency or even using blockchain. The currencies they issue now are mostly digital and most people don't use cash most of the time now anyway. To me, the issue is really more are you going to let individual private citizens open a bank account at the Fed instead of their corner private bank. Their concern is that people might flee the private banks in a crisis to the perceived "safety" of holding their money at the central bank. The Bank of England talked about that issue a long time ago and we covered that on the blog. I have no indication that those kinds of decisions have been made yet at any of the major central banks studying this.