This year, bitcoin has mesmerised many investors. Never mind the fact that it has doubled in price, after tripling in 2020; nor that figures such as Elon Musk have backed it — this week he tweeted that Tesla cars will be sold in bitcoin. What is even more remarkable is that some establishment players such as Citigroup now think bitcoin “may be optimally positioned to become the preferred global currency for trade” in the future, a role currently occupied by the dollar.
But while this is headline-grabbing, there is a second crypto tale unfolding that most people have noticed less: central bank experiments. This week the Bank for International Settlements held an “innovation” conference, at which Jay Powell, Federal Reserve chair, explained that Fed officials are working with the Massachusetts Institute of Technology to explore the feasibility of a dollar-based central bank digital currency.
Details are sparse. But a CBDC essentially enables consumers to use computerised code as “money”, thus echoing some of the features of bitcoin, or the type of crypto coin being developed by Facebook. But this computer code would be created and controlled by the Fed — not Facebook or faceless bitcoin “miners”. Powell stressed this digital dollar would not emerge quickly, if at all, saying “there is no need to rush”. But the symbolism is striking, since it reflects a subtle but notable shift in attitude among regulators.
When bitcoin and other fintech innovations first emerged this century, many central bankers either dismissed or derided them in conversations with me. They remain so: Powell suggested this week that bitcoin was primarily a speculative investment substitute for gold, not for the dollar; Agustín Carstens, BIS head, warned it was mostly used for regulatory arbitrage.
But what central bankers are belatedly realising is that the reason such innovations have emerged is that entrepreneurs are responding to two big flaws in modern finance.
One revolves around something that central bankers seem unwilling or unable to address: the risk that fiat currency is debased in the future by excessive supply, ie quantitative easing. The other is something central bankers do want to address: the clunky nature of the modern payments system. As Powell recently observed: “The Covid crisis has brought into even sharper focus the need to address the limitations of our current arrangements for cross-border payments.”
Thus, what the Fed and others are now trying to do is a mild version of the “if you can’t beat ’em, join ’em” strategy: instead of ignoring bitcoin or Facebook’s experiments, they hope instead to harness some of the ideas behind such innovations as blockchain ledgers on their own terms. Or, if you like, out-crypto the crypto kids.
Will it work? There are reasons to be sceptical. One problem is style: asking stodgy central bankers to embrace the type of freewheeling creativity found in fintech is like asking grandpa to listen to rap. Another, even more daunting, issue is that CBDCs create huge policy headaches, such as the future role of private sector banks.
Commercial banks currently earn fees by “creating” money for consumers, (loans), by using money supplied (or created) by a central bank. A CBDC, however, would give consumers money (digitised tokens) inscribed on the computing ledgers of central banks. This could potentially disintermediate banks in a way that would shatter revenues, as Jens Weidmann, head of the Bundesbank, told the BIS. He suggests that if the eurozone creates CBDCs, it might need to retain a two-tier distribution system to keep banks involved.
Then there are data, privacy and liability issues. Central banks might not want to hold consumer data on their ledgers. Investors might hate losing the anonymity associated with cash.
A possible solution is that CBDCs could coexist with cash, which is what Powell expects to see. But the logistics and legal framework for this could be daunting, not least because a recent BIS survey suggests that only a quarter of the world’s central banks have clear legal authority to create such a currency.
Yet it would be wrong to assume nothing will happen, just because the logistics look daunting. The same BIS survey suggests that 60 per cent of central banks are considering CBDCs and 14 per cent are carrying out pilot tests. “The Covid-19 pandemic has added new motivations to this journey,” it notes. “While most [central banks] have no plans to issue CBDCs in the foreseeable future, central banks collectively representing a fifth of the world’s population are likely to launch retail CBDCs in the next three years.”
The Bahamas is one example: it already has a CBDC, called the sand dollar. More significantly, China is now racing to create a digital renminbi, sparking US angst about competitive threats to the dollar. Which might explain why the Fed has suddenly teamed up with MIT.
This may not be as thrilling as a Musk tweet. But the key point is that if such initiatives eventually fly, they could displace some of the rationale for private sector crypto projects. The would-be disintermediators of fiat currency might thus be disintermediated themselves. If so, that would be distinctly ironic. Bitcoin investors should watch Beijing — and Boston.