Central Bank Digital Currencies gather steam

British bank notes

Central Bank Digital Currencies, or CBDCs, are gathering steam. The years since the 2008 financial crash have seen both the emergence of cryptocurrencies and a rapid rise in the use of digital forms of payment. The Bank of England published their second discussion paper on CBDC a few days ago, and Governor Andrew Bailey told the Association of Corporate Treasurers conference that digital currency is “part of what a Central Bank is all about.” I was recently invited onto BBC Radio 4’s Moneybox to talk about CBDCs, what they mean for us, and what cryptocurrency means to the wider world.

Why we need CBDCs

In a recent speech, Sir Jon Cunliffe, Deputy Governor (Financial Stability) of the Bank of England explained the distinction between public and private money. People rarely realise that the money in our traditional bank accounts is not the same as a bank note. Rather, it is private money issued by the individual banks, although it can be exchanged freely for cash, public money, at ATMs. This is why there is so much regulation around banks, for example the bank deposit guarantee scheme in the UK that covers (currently) personal deposits up to £85k in the event of the failure of one of these private banks.

That means that all of the electronic banking that we do, moving money by fast payment or paying by chip and pin or contactless card, is private money. You can’t do anything digital with public money, bank notes, right now. However, the overarching stability provided by their very existence, their promise to ‘Pay the Bearer on Demand’,  is the glue that holds the monetary system together and helps the Bank of England to keep inflation low and our day to day costs steady. In this country, you don’t go to the store wondering whether your bread will be one pound or five today. That is not the case for every economy.

If monetary stability relies on confidence in public money issued by a central bank, then that money needs to stay up to date and be made available in a digital format alongside physical cash.

There’s a more pressing concern for central banks around the world, too. A cryptocurrency like Bitcoin or Ethereum sits on a public ledger, rather than inside a bank. Cryptocurrency is public money in the same way that bank notes are public money.  Can large economies risk the population turning to crypto, whether traditional or issued by big tech firms, and making non-digital public money obsolete?

Bitcoin as legal tender?

One country that has jumped straight into public crypto is El Salvador. This is an interesting case to mention because they have passed legislation to make Bitcoin legal tender alongside the US Dollar. Neither of these currencies is under the control of the state, so there is no impact on monetary stability, other than, perhaps, reducing reliance on the US Dollar. In terms of financial stability, they hope to take advantage of the borderless nature of Bitcoin to improve the flow of remittances from ex pat El Salvadorians, a sum estimated to make up 20% of the country’s GDP. Whether this bold step helps to improve digital as well as financial inclusion remains to be seen, and it will be very interesting to see how the adoption progresses and whether other countries in the same position also take action.

Risks and opportunities

Most of the risk of using any type of digital currency comes down to the effectiveness of your cybersecurity practice. The scams and malware that have always circulated in an attempt to part us from our hard earned cash are designed to target not just traditional deposits but crypto too. Phishing emails capture logins and plant trojans on computers, malware sneaks in through older devices that are out of date for security updates, and convincing scam calls persuade the unwary to move money from A to B, never to be seen again. Public cryptocurrencies are also susceptible to the classic human error of forgotten passwords and lost access. Central Bank Digital Currencies would protect us from ourselves, to some degree.

Programmable money

Digital currencies make the machinery of payment run more smoothly, giving us cheaper payments and faster settlement. As they are software, they are also programmable. Public digital currencies are programmed to execute transactions on their individual blockchains, for example. Other ‘coins’ – NFTs – act as certificates of identity or ownership, enabling us to track the movement of everything from Durian fruit to fine art. If digital money can be programmed to have specific roles or even to collect data, would you rather the central bank was in control, or a global tech firm like Facebook?

Sustainable crypto

Finally, what about the environmental impact? There are valid concerns around the energy use and carbon emissions of Bitcoin. It’s important to say that Bitcoin was the first cryptocurrency, a successful proof of concept, and the energy-hungry Proof of Work consensus that allows the ledger to be maintained was the best available option at the time. There is a lot of work underway to incentivise the use of sustainable energy sources, and El Salvador has suggested using geothermal energy from its volcanoes to power Bitcoin mining. As the adoption of crypto accelerated, developers looked for new ways to manage consensus and improve sustainability. Ethereum, the second major cryptocurrency, made it a goal in 2015 to move to a Proof of Stake consensus as soon as this was technically possible, and may deliver on the promise this year. Newer currencies, including CBDC, are developed with sustainability in mind, and signatories to the Crypto Climate Accord are aiming at net zero operation by 2040.

A future of digital money

There are a handful of CBDCs running right now, notably the Bahamian Sand Dollar and the Digital Yuan in China, and central banks globally are on the road towards their implementation. If you want to help shape the UK’s version of digital cash, you can respond to the discussion paper here. What the final form will take is uncertain, but it is very likely that when CBDCs roll out, most of us won’t even notice it happening.


Glossary: Crypto and CBDC jargon

Bitcoin, Ethereum and other pure, public cryptocurrencies are borderless, censorship resistant, transparent and immutable, but notoriously volatile in value. What does all this mean?

Transparent : Anyone can go to the public ledger and look at a transaction. It won’t be written out in longhand, but you can confirm that a sum of money or a digital asset (like an artwork) moved from the ownership of one person to another.

Immutable : You may be able to see the transaction, but you can’t change it thanks to the way the ledger is designed. Transactions are held in a chain of blocks that all refer back along the chain. To change one thing means changing everything that came after it. This is not a private database or a spreadsheet that could be manipulated, adjusted or deleted.

Borderless and censorship-resistant : There is no national body controlling these cryptocurrencies, and they are global. Anyone who has access to the internet (even intermittently) can have access to a cryptocurrency. This is important because it gives people who do not have the luxury of our banking infrastructure the chance to transact across borders, keep an honest ledger of payments and receipts, and even access decentralised financial services such as loans.

Volatile : The Bank of England is tasked to keep inflation in the country under 2%, and this involves planned, regulated monetary policy. As public cryptocurrencies are not part of any nation’s policymaking or control, confidence can wax and wane and they can appear highly volatile against a stable currency. Against an unstable currency with no discernible monetary control, Bitcoin and others are by contrast safe havens. To avoid untethered volatility, Central Bank Digital Currencies are designed as stablecoins with the same value as cash. This isn’t a new concept, just a new technology, as the Bank of England’s Christina Segal-Knowles explained recently. Private stablecoins have been part of the crypto world for several years.