The landscape for digital currencies and assets continues to evolve.
Central bank digital currencies (CBDCs) are moving from conceptual analysis to practical design, and regulators are concerned about the potential impacts of crypto-assets.
CBDCs — from theory to practice
In June 2021, the Bank for International Settlements (BIS) revealed (PDF 2.5 MB) that approximately two thirds of the 50 central banks it surveyed were conducting CBDC experiments or pilots. Global standard setters and regulators agree that there are potential benefits to the deployment of CBDCs. The establishment of trusted digital currencies, backed by central banks, can improve the efficiency of cross-border payments and lower barriers to entry for new firms in the payments sector, while embracing the digital world. A joint report (PDF 1.3 MB) to the G20 by the Committee on Payments and Market Infrastructure (CPMI), the BIS Innovation Hub, the International Monetary Fund (IMF) and the World Bank agrees that CBDCs have the potential to enhance the efficiency of cross-border payments, if countries work together.
According to Benoît Cœuré, head of the BIS Innovation Hub, “CBDCs could form the backbone of a new digital payment system by enabling broad access and providing strong data governance and privacy standards. They are the best way to promote the public interest case for digital money.”
Implementation of CBDCs will not be without challenges, the greatest being the threat of identity fraud and privacy concerns. An ECB study found that privacy was the greatest concern among EU citizens and suggested that there might be resistance to digital IDs. The BIS has a possible system of anonymity vouchers for small value transactions but notes that “identification at some level is … central in the design of CBDCs”.
There is agreement that the specific design of any CBDC will be critical in delivering benefits. The BIS recommends that CBDCs would function best as part of a two-tier system, with the bulk of customer-facing activities taken on by banks and other payment service providers. The most promising design for general use, it says, is a CBDC built on a digital identity scheme as this can safeguard data privacy while offering protection against illicit activity - this may also assist in streamlining cross-border payments. And, critically, digital money should be designed with the public interest in mind.
Responses to the Bank of England's 2020 discussion paper on CBDC and a further discussion paper on new forms of digital money result in five core principles, which largely echo the BIS position:
- Financial inclusion should be a prominent design consideration. CBDCs should have a high degree of accessibility to people, regardless of their geographic location, age, socioeconomic status, digital skills or disability.
- A competitive CBDC ecosystem with a diverse set of participants will support innovation and offer the best chance to deliver the benefits of CBDC. The central bank should provide the minimum level of infrastructure for the system to be reliable, resilient, fast and efficient. The private sector should take a leading role in responding to the needs of end-users.
- The central bank should assess whether non-CBDC payment innovations could deliver the same benefits, for example to what extent the net benefits of a CBDC could be delivered by private sector proposals.
- A CBDC should offer a strong level of privacy to users and meet important legal and compliance arrangements, such as anti-money laundering, countering the financing of terrorism and sanctions.
- A CBDC should “do no harm” to the central bank's ability to meet monetary and financial stability — possible benefits for monetary and financial stability should be considered alongside those for payments.
The ECB has launched a 24 month investigation phase into a digital euro. Earlier research found that a CBDC matters for international currency status and would have the potential to widen access to payment services, promote financial inclusion and reduce the mark-ups of traditional intermediaries. Additionally, the specific design features of a CBDC would influence “the ability and incentives of residents and non-residents to use the CBDC as a means of payment, unit of account and/or store of value”. The latest announcement confirms that no technical obstacles were identified during the preliminary experimentation phase and that any design will be based on users’ needs and technical advice from merchants and intermediaries. The project will also consider changes which might be needed to the EU legislative framework.
For some though, the pace of change is too slow. France and Germany are pressing for more urgent action to avoid Europe becoming dependent on other countries or private companies for digital payment systems.
Choppier waters for crypto-assets
Whereas CBDCs appear broadly to have the support of regulatory authorities, the wider universe of crypto-assets is attracting less welcome attention.
In May 2021, China banned financial institutions and payment companies from providing services related to cryptocurrency transactions and warned investors against speculative crypto-trading (although it stopped short of prohibiting individuals from holding cryptocurrencies). This action was widely viewed as an attempt to damp down the growing digital trading market. Firms are not permitted to offer any service involving cryptocurrency, including registration, trading, clearing and settlement.
Also in May, the Governor of the Bank of England, Andrew Bailey, made his feelings on cryptocurrencies very clear, saying that they “have no intrinsic value” and that those who invest in them should be prepared to lose all their money.
The Basel Committee for Banking Supervision (BCBS) seems to agree on the point of value. Preliminary proposals (PDF 390 KB) for the prudential treatment of banks' crypto-asset exposures consider the different types of digital assets and suggest a two tier system:
- Group 1 — crypto-assets fulfilling a set of classification conditions, which would be eligible for treatment under the existing Basel framework with some modifications and additional guidance. This group would include certain tokenised traditional assets and stablecoins.
- Group 2 — crypto-assets, such as Bitcoin, which do not fulfil the classification conditions. Since these pose additional and higher risks, they would be subject to a new, conservative prudential treatment. This treatment would effectively require banks to hold capital equivalent to the full amount of the exposure.
The message is clear — not all digital assets are equal in the eyes of governments and financial services regulators. Around the globe, authorities are doing everything they can to separate the potentially beneficial and innovative from the purely speculative and, in so doing, to protect both the financial integrity of markets and limit potential harm to customers.