CBDCs: Falling short in theory and reality
This week I thought it would be interesting to give a quick comment on the debate that continues around central bank digital currencies (CBDC).
I thought the FT made a neat point by headlining a piece on the subject with, The digital euro: a solution seeking a problem?
The same old problems
The ECB is currently running a consultation on the strengths and weaknesses of issuing a digital Euro, or a retail CBDC.
While the ECB’s rhetoric in recent months seemed to place it in the ‘positive’ camp, last week, the European Parliament published a paper that essentially stated why it believed the risks of CBDCs outweigh the benefits.
The FT article we mentioned above highlighted the main issues raised by the paper. They focused on 3 themes:
Would a CBDC actually make any difference to consumers over and above digital/mobile payments?
Is there a risk that the banking system is destabilised if everyone withdraws their savings from banks and then holds them as digital-Euro?
Can privacy ever be truly guaranteed with CBDCs?
These themes aren’t new. We’ve been talking about them on the blog for some time. And it’s now got to the point where it’s noticeable how the same themes are consistently being raised by critics as reasons why CBDCs fall short. The fact solutions have yet to be found mean that, in theory and reality, CBDCs are nowhere near ready for consumers.
Adoption and usage
We spoke about the first theme back in February, highlighting China (which continues to play host as the world's most advanced CBDC pilot) where the PBOC is giving away eYuan because there is such little usage. In a country where such a high percentage of payments are already digital (usually via WeChat), the benefits of the digital Yuan remain unclear.
To address the second theme, the ECB proposes a €3,000 limit for individuals who want to access the CBDC in its first instance. Considering how the digital Euro doesn’t earn any interest, you have to ask why they would make anyone’s life easier? In theory, retail CBDCs offer consumers the security of not being beholden to the balance sheet of a high street bank, a shortcoming of the existing system that was highlighted in recent months by the collapse of SVB (amongst others). But with a €3,000 limit, security of savings is hardly possible.
In fact, do CBDCs make it harder for consumers who have to manage 2 apps, 2 different balances? By adding complexity, it’s even less likely people will adopt, and this supports the argument that what we have right now isn’t perfect but it works ok. If it ain’t broke etc…
The primacy of privacy
The third theme around privacy is the most important. As I commented in my conclusion of the piece we wrote in February, one of my concerns is that, if we’re not careful, CBDCs will put us on “the slippery slope of authoritarianism and a loss of civil liberties.”
Quite sensibly, the European Parliament seems to be playing it safe by saying: “We can’t predict how the tech could be co-opted if a nefarious government came to power. So, it’s better to be safe than sorry, and not let the genie out of the bottle in the first place.”
This is fair. The forking of crypto blockchains, creation of new tokens, “rug pulls,” and other such activity in the crypto world has demonstrated that just because you think something has been neatly coded, it’s impossible to reduce vulnerability to zero. Given the risks of the “unknown unknown”, the European Parliament clearly believes that there is more risk in doing something right now, rather than not.
Retail versus institutional
The ECB paper and the majority of the debate taking place right now focus on retail CBDCs, the kind I would use to buy a coffee. They rarely focus on institutional CBDCs, the type that banks might use for large-value transactions with one another.
In the world of DCM, and especially in our world of institutional DCM, I can see big benefits in a wholesale CBDC, especially if it would assist with the implementation of the Holy Grail of “smart contracts” and “self-executing securities.” The benefits of those technologies don’t exist in the world where cash payments still need to be made via “legacy” payment rails – but they could if there was a reliable institutional CBDC underpinning the process.
For now, with these theoretical upsides possible at some point in the future, I welcome the ongoing exploration of CBDCs. But my view, especially on retail payments, is that central banks need to tread super carefully. The back and forth on the subject seems to snag on the same issues – privacy, security and usage. Until they can be put to bed (at least in theory), CBDCs, retail or institutional, will remain theory and nowhere near reality.
