Central banks need to slow down on digital currencies

Cryptocurrency update

The emergence of central bank digital currency (CBDC) is inevitable. Research on the design and implementation of CBDC is being carried out worldwide. China has been in this process for seven years and already has a pilot program for e-CNY or digital RMB. The European Central Bank’s goal is to launch one by 2025. However, the Bank of England and the Federal Reserve moved more slowly. I think they are right. The inevitable is not necessarily optimal.

In the past 15 years, the world financial ecosystem has undergone earth-shaking changes. Cryptocurrency and fintech companies are threatening to move payments, deposits and loans from the banking industry to unregulated networks. This may create a wild west for international finance, threaten the stability of the industry and weaken the ability of the central bank to fulfill its mission. Supporters of CBDC say that the only defense is for policymakers to retain ultimate control over financial transactions.

Through CBDC, companies and individuals can directly open accounts with the central bank. Although this can improve efficiency, it will end the role of banks in financial intermediation. The core of the banking business model is to use deposits to issue loans and collect fees. Due to the unstable deposit base, this practice and bank profits will decrease. Loans will decrease, dragging down overall growth. In order to make up for the loss, the bank may charge more payment services and account fees. A cheaper and more inclusive financial system ends here.

Politically, it is difficult for the central bank to fill the loan gap by assuming the role of credit distributor. It also requires the central bank to undertake new operational tasks, such as credit risk and Know Your Customer (KYC) analysis. More likely, a system must be designed so that customers can hold CBDC accounts with banks or other intermediaries that provide services.

This presents its own challenges. Since CBDCs are backed by the central bank, they are more secure. In a crisis, this may lead to a bank run, because customers no longer use cash. Even if the interest rate offered by commercial banks to depositors is higher than that of CBDC, they may not be able to effectively hedge. Restrictions on CBDC holdings will leave opportunities for unregulated cryptocurrencies and may weaken competitiveness with other CBDCs.

Fans of CBDC believe that they will promote inclusiveness by letting everyone have a bank account. This ignores the problem of people who are not connected to the Internet. Privacy is also an issue. Do customers even want quasi-government agencies to know the details of their expenditures? A token-based system, similar to verifying cash instead of the owner, will allow anonymous use of CBDC.This might attract 23% of the U.S. population without a bank account The report says it does not trust the bank and wants privacy. But it will not be compared with anti-money laundering or sanctions authorities.

At the same time, the central bank is solving the problem of settlement speed by developing an instant payment system. If CBDCs are interoperable, they may make cross-border payments faster and cheaper.But this will require the central bank to establish corridor Have an agreed structure and governance.In one there is 200 currencies, This will require a large number of bilateral arrangements that are not feasible. Even with CBDC, anti-money laundering efforts will slow down efforts to modernize cross-border payments.

The international financial system must be updated for the digital age, and the central bank will take the lead. Distributed ledgers and other technologies have the potential to improve the efficiency of payments and invoices. But the correct design of CBDC is crucial. Simply assuming that “if it is digital, it must be better” is an oversimplification. In this case, speed is not important, and the Fed and the Bank of England are acting wisely and cautiously to get it right.

The author is a senior researcher at Harvard Kennedy School

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