- Could Digital Currencies Make Being Poor Less Costly?
- Ripe for Disruption
- A Way Forward
- A System We Need Now
- Central Bank Digital Currencies (CBDC) are the Polar Opposite of Bitcoin | by SatoshiLabs
- Don’t central banks already have digital money?
- Inspired by Bitcoin
- How an official CBDC will work
- What this means for us mortals
Could Digital Currencies Make Being Poor Less Costly?
By definition, blockchain technology cuts out middlemen. In relying on networks of users and collective trust, it reduces the need for centralized networks and data storage.
This trait made blockchain-powered currencies popular on shadowy parts of the internet, but it has the potential to do something more revolutionary than obscure how money is changing hands: Blockchain-based payment systems can bring the more than 1.
7 billion people who are unbanked or underbanked (including 25% of U.S. households), into the formal economy. And in doing so, they can render obsolete the expensive, usurious payment and informal financial services those people use to make ends meet.
A generational pandemic makes this challenge all the more urgent, as decades of (admittedly uneven) economic progress are erased.
Right now, more than 70% of the world’s central banks are exploring the merits of central bank digital currencies (CBDCs) — electronic versions of their national fiat.
This is a bigger deal than you might think: A national digital currency could reduce reliance on commercial banks as the principal interface for money management and increase optionality for consumers, many of whom are beyond the reach of physical bank branches or excluded from the financial system due to poor credit or lack of funds.
Because of the decentralized way that blockchain-based payment systems work, they empower people with the 4S’s of payments, namely how they spend, save, send, and secure their money.
However, for this to work we will need open and interoperable payment rails — universal, open, and user-directed payment networks. Extending the perimeter of the formal economy while lowering the costs of service is not only altruistic, it’s a means to market expansion and lowering risk from the reliance on opaque financial networks.
Ripe for Disruption
It is expensive to be poor, remote, and disconnected, and it has been for a long time.
Issues of price, competition, access, and connectivity in banking and payment networks today look similar to telephone networks 50 years ago: At the time, the only people who had reliable access were those who lived in the right country or postal code, andbillions of people went without reliable, low-cost communication.
Breakthroughs in mobile telephony and broadband, alongside low-cost mobile devices — which, as it happens, more than 1 billion of the 1.7 billion people who are unbanked have access to — made it possible to extend the reach of human connectivity. It is now time to begin connecting those dots, turning an internet-ready mobile phone into a regulated payment endpoint.
An internet-ready mobile phone is the bottom rung of economic mobility. While it’s well established that breakthroughs in mobile banking have improved financial inclusion, blockchain-based payment systems have the potential to reduce costs and improve access even further.
The best example of this opportunity are the world’s peer-to-peer remittance cashflows, which totaled more than $700 billion in 2019. The cost and friction-laden process of sending a remittance — in which costs average 7% globally, but can run much higher — leaves a lot to be desired and exacts the heaviest toll on the people who can least afford it.
This flow of money is so important that the United Nations has set a target to lower the cost of remittances to 3% as a part of the Sustainable Development Goals.
Achieving this, however, will be elusive short of large-scale, open-source technological modernization of the world’s payment networks. Public-private collaboration and hybrid approaches to CBDCs can ensure the right balance between necessary levels of compliance and innovation are struck in lowering the costs and complexity of cross-border cashflows.
A Way Forward
So, what would an open peer-to-peer payment infrastructure look ? And how would it work with CBDCs? As a first principle, we cannot run a science experiment on the world, and least of all on financially vulnerable people, who may also labor under technological literacy challenges.
Practically speaking, there are two ways to achieve this safely: 1) promote regulatory certainty and vigorous promotion of competition around the growing wave of stablecoin projects, and 2) create regulatory sandboxes where various experiments with CBDCs of the wholesale, retail, and hybrid variety can be tested, along with the public-private collaboration that can make last-mile use cases a reality. Just as standardizing global messaging platforms have broadened the base of connectivity by billions of users, the opportunity of compliant blockchain-based payment networks can similarly extend the perimeter of the formal economy and lower the bottom rung of economic mobility, thus completing the financial system, rather than competing with it.
Second, un most other disruptive technologies, which evolve rapidly and fix problems along the way, it’s essential for this system to start by getting compliance right, particularly when it comes to satisfying stringent post-9/11 requirements on anti-money laundering, countering the financing of terrorism, and giving illicit actors no place to hide.
This includes developing frameworks that can harmonize the regulatory treatment of digital assets around the world, including so-called global stablecoins, which is an area of review by the Financial Stability Board, an international body that monitors the global financial system.
One of the key areas of opportunity to extend the perimeter of payments is the development of tiered, “know your customer” (KYC) requirementsas well as addressing the global identity gap, in which more than 1 billion people have no nationally issued ID.
Here too, the application of blockchain technology, along with biometrics, can improve outcomes for the provision of citizen services (beginning with being counted), including financial access. (The Kiva Protocol project in Sierra Leone offers compelling digital identity directions.)
The third, is that solutions and technologies must be open source.
Traditionally, there has been a lack of broad competition for basic services, particularly in payments, and so enabling free development of mobile-native digital wallets — the on-ramps for gaining access to blockchain-based payment systems whether they carry stablecoins or CBDCs — would ly result in broader reach than the traditional world of “brick and mortar” financial access could achieve. Extending the perimeter of the formal economy in a way that balances compliance, risk management and responsible financial services innovation is not about disruption, it is about optionality.
There’s precedent for how central banks, public authorities and the private sector might go about building this kind of infrastructure. Innovation of low-cost, user-directed internet-ready payments has mostly come from Asia, and these innovations are quickly becoming mainstream.
Of all the central banks exploring the risks and opportunities of digitizing their national currencies, China’s central bank aims to be the clear winner when it comes to retail, household-level ambition.
While most CBDC experimentation is mainly concerned with the wholesale banking layer — between central banks and counterparty private sector banks — China’s focus on the peer-to-peer, user-directed domain, is poised to unlock a wave of digital currency competition.
A System We Need Now
The pandemic has made the utility of this kind of system clear, not just for international payments, but for domestic financial health in the United States. The initial draft of the U.S. CARES Act, which mobilized $2.2 trillion in economic relief and included direct payments to U.S.
citizens, called for the creation of a digital dollar and a citizen digital wallet to facilitate real-time direct payments. However short lived this language was in the original bill, the competitiveness, poverty alleviation, and economic gains that can be achieved cannot be overstated. In the U.S.
, where roughly 51 million Americans have lost their jobs due to Covid-19, more people are forced to rely on payday lending and extortionate credit debt; many of the neediest families waited for many weeks to receive their physical checks.
For rural communities and others, the concept of cashing a physical check, much going to a physical remittance location to pick up money, is not only cumbersome, it is costly and in the midst of a communicable disease outbreak, it is perilous.
Digital currencies and blockchain-based payment systems on their own are not solutions for endemic levels of poverty and financial exclusion.
Along with uncommon coalitions, strong governance principles, such as those espoused by the World Economic Forum’s newly-released Presidio Principles, can make a difference in digitizing payments, without imperiling users to fraud, hyper-volatility and lax levels of risk management and compliance, which have plagued many blockchain-based financial services in the past. This now 11-year old technology is coming of age, having survived “crypto winter” and gaining much needed regulatory clarity around the world. What the pandemic underscores in perhaps all aspects of our lives except for payments, is that ubiquitous access to technology — whether teaching millions of students remotely via Zoom – is that the case for open, blockchain-based payment networks and the stablecoins or future CBDCs they may one day carry has also come of age.
Central Bank Digital Currencies (CBDC) are the Polar Opposite of Bitcoin | by SatoshiLabs
Inspired by Bitcoin, but delivering something completely different: Central Bank Digital Currencies. Lately, central banks have felt the urge to make their own digital money, so as to have as much control as possible over the future of digital currency.
The CBDC, as the novelty is known today, has a legacy older than cryptocurrency, but has only become a recognized concept in the wake of Bitcoin.
Here and there they are still connected to the now-familiar term “blockchain” and it is not so surprising that, for the public, CBDCs have become understood as a kind of “state-run cryptocurrency”, but nothing could be further from the truth. In fact, CBDCs are, in many ways, the polar opposite of Bitcoin.
Don’t central banks already have digital money?
No, they don’t. Central banks have much less control over money than we often grant them credit for. Most importantly, they have less control than they would to have. Money is created by commercial banks, and central banks only set the limits and rules by which they try to achieve their goal — generally, a stable increase in prices.
Central banks usually do not even print physical money. Printers do that at the request of commercial banks, while central banks only mediate the process.
Most importantly, the central bank doesn’t usually create money, it just exchanges digital money for non-digital money of the same value.
Just imagine, if the central bank wanted to give someone some money, how would they do so without throwing it at people from a helicopter? They really have much less control over money than we tend to think.
After the crisis in 2008, Western central banks hit their limit, the so-called zero lower bound. Interest rates cannot be reduced too much below zero, so other ways have been sought to support consumption and thus promote a general increase in prices.
The US Fed or the European Central Bank tried quantitative easing, while Trezor’s domestic Czech National Bank, for fear of deflation, introduced an exchange rate commitment and purposefully weakened our currency.
Central banks tried everything, but in the midst of it, there was a story that would soon give the central banks a new power: the ability to create their own digital money, the CBDC.
Inspired by Bitcoin
Of course, it was necessary to explain carefully that blockchain is not a magical technology in itself, and when economic motivations in the form of cryptocurrency are removed from the equation, only an interesting but not very effective database remains.
Big companies caught on and started offering blockchain wherever it was possible. To authorities, to companies, to banks, and also to central banks. Let’s not discuss just now whether or not it makes sense. The fact is that central banks have begun to find a way to make their own money — and they were inspired by Bitcoin.
We know this from the very first known use of the term CBDC, in 2016, when the Bank of England acknowledged that the idea of central bank digital money was inspired by Bitcoin.
While this tale of inspiration is remarkable, somehow the resulting product is the exact opposite of what Bitcoin represents.
Of course, when we say the exact opposite, we look not at the form they take but at their properties. That it will be digital, virtual and will use certain principles of cryptography should not surprise us much, because digitalization is already happening today with our current money. But everything that makes Bitcoin revolutionary is discarded.
A CBDC is a centralized system with reversible and censorable transactions, where you must fully trust the central institution to keep its word. Bitcoin is a decentralized trustless system with irreversible and immutable transactions.
As a result, CBDCs can also be cheap and fast, while on-chain transactions in Bitcoin are notoriously expensive and slow; it’s a trade-off which we must weigh against the benefits we, the people, gain from each.
In terms of individual liberties, CBDCs and Bitcoin weigh heavily on opposite ends of the scales. The former is a means of control, the latter a torch of freedom.
How an official CBDC will work
It will be simple. You open an account with a central bank, where you can send your wage or transfer money. The central bank will buy government bonds against all deposits. So the CBDC will thus be backed by (but not redeemable for) government bonds. Un your bank, it will also pay you attractive interest on those deposits to motivate you to transfer money there.
Ok, so we will have two types of money in circulation. We would have “bank money” and a CBDC. We would then use the central bank account as we normally would use our current accounts. It might even be just a little better, because the central bank would add interest to our current account.
But it comes at a price. Why should you, in this system, store money in your bank? Economists discussing the CBDC are fully aware of this and state that bank runs — where people liquidate their bank accounts for cash — pose a great risk. People would simply withdraw their money and send it to a central bank account where it would bear better interest.
Of course, banks would to prevent this and would have to offer higher interest rates on their accounts, which would lead to lower profits and, for some banks, would necessarily lead to bankruptcy or the mergers with competitors. Or, deposits with the central bank would instead have to pay interest only for a certain amount of deposit, which is a more realistic idea.
Proponents of the CBDC show that this would lead to a one-off problem in the banking sector but, on the other hand, it would be more stable in times of financial crisis.
It is almost a perpetual motion machine which lets the government get the best possible sale point for its bonds — a central bank with an infinite money supply.
Well, not that the world’s central banks aren’t doing it already, but it’s not as straightforward.
On the assets side, however, it does not have to be just the purchase of government bonds. Central banks around the world are browsing other investments, and some have tested other purchases, such as corporate bonds. They can also lend to banks against household deposits, which they are already doing on a large scale.
Or, and this is already a big fantasy, though not unrealistic, the central bank could provide loans directly to people and companies. This is something that central banks largely reject at present.
They don’t need it and they don’t want to do it, it is much easier for them to buy bonds so it remains their tried-and-tested preferred method.
The idea of a CBDC can take many forms and the proposed systems vary. The example described above is the most extensive form of implementation, where households and companies also have access to CBDC.
In another form, CBDCs may only be available between banks and the central bank, or between the banks themselves. There is also a debate about whether or not they should be exchangeable for bank money on demand.
If not, the system would again work slightly differently and have a different impact.
What this means for us mortals
So far, there is nothing to be afraid of (or to cheerfully look forward to, if you the sound of the proposal). It is still a marginal topic and would probably require a change of the constitution, and all testing is still in its infancy.
Sooner or later, however, the CBDCs will come. They do not pose a danger to Bitcoin: they are not its competitors, they are its exact opposite in terms of intent. But they pose a danger to banks.
The centralized banking system will become even more centralized and the central bank will gain new powers and tools. Monetary policy will be one step ahead again — this time, at the expense of banks.
All this looks a transfer of profits from banks to the central bank, which would not bother the public if they were to receive higher interest rates on deposits in return. However, it is not all going to come for free.
As a result, central banks will inflate their balance sheets by buying assets, which will increase asset prices and run hand in hand with lower yields. Low asset returns and rising asset prices are already pushing more people into speculation, inflating bubbles in financial markets and increasing income inequality as asset prices help the rich while the poorer wait for their wages to grow.
The media will continue to write about CBDCs as a competitor to Bitcoin. This is completely at odds with reality. CBDCs have the potential to compete, but mainly with the banks, or better with the traditional money we use today.
That they were inspired by some Bitcoin standards is true, but CBDCs and Bitcoin do not fit into one category. It’s as if Harry Potter was competing with the United States Constitution as the nation’s guiding light, because both texts used the technique called writing on paper.
You may find some interesting points of debate there, of course, but the technology at its heart is the least interesting.
Some of us thought, ten years ago, that central banks were running breath. I was one of these people; we were wrong. Central banks still have enough ammunition, they can invent new tricks and they can inflate their balance sheets indefinitely.
They will do anything necessary in their hunt for inflation and they must, by law, so it is not surprising that they are fighting back.
The proposal of a CBDC should mean little for Bitcoin and buying assets to cover deposits, which will in turn benefit people through higher interest rates, sounds much better than boring quantitative easing. In practice, however, the effects are much the same.
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