New cryptocurrencies are emerging almost daily, and many interested parties are wondering whether central banks should issue their own versions. But what might central bank cryptocurrencies (CBCCs) look like and would they be useful? This feature provides a taxonomy of money that identifies two types of CBCC - retail and wholesale - and differentiates them from other forms of central bank money such as cash and reserves.
- "Central bank cryptocurrencies", Bank of International Settlements, Sept. 17 2017
In addition to its traditional observations on the state of the global financial system (which today also included a warning that global debt may be underreproted by as much as $14 trillion due to rampant use of FX swaps), in its latest quarterly review, the Bank of International Settlements, takes on cryptocurrencies, and specifically whether central banks should be worried by their exponentially fast propagation, it not quite adoption. Echoing the paradox first voiced by Bundesbank chief Jens Weidmann in June, namely that "digital currencies will make the next crisis worse" by pointing out that digital currencies - whose flow can not be blocked by conventional means - make an instant bank run far more likely, and in creating the conditions for a run on bank deposits lenders would be short of liquidity and struggle to make loans.
“My personal take on this is that central banks should strive to make existing payment systems more efficient and still faster than they already are – instant payment is the buzzword here,” the Bundesbank president said at the time, adding that "I am pretty confident that this will reduce most citizens’ interest in digital currencies.” Ironically, considering the recent all time highs in bitcoin, ethereum and other cryptos and record users on the US Coinbase exchange, would also suggest that citizens faith and confidence in the existing "payment systems", and thus central banks, is at all time lows.
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Perhaps this is what prompted the BIS to tackle the sensitive topic of both cryptos and digital currencies, warning that the exponential growth in cryptocurrencies could pose a risk to the stability of the financial system. Among other observations, the BIS stated that central banks will need to figure out whether to issue a digital currency and what its attributes should be. Complicating matters, the BIS which has a habit of hedging every single statement and idea, also warned that institutions need to take into account of not only privacy issues and efficiency gains in payment systems, but also economic, financial and monetary policy repercussions.
The BIS analysis takes place several months after the Dutch central bank announced plans to create its own blockchain-based currency if only for internal use only, and after the BOE's Mark Carney said cryptocurrencies could be part of a potential “revolution” in finance. As Bloomberg adds, U.S. officials are exploring the matter too, though in March Federal Reserve Governor Jerome Powell said there were “significant policy issues” that needed further study, including vulnerability to cyber-attack, privacy and counterfeiting.
According to the BIS, one option for central banks might be a currency available to the public, with only the central bank able to issue units that would be directly convertible with cash and reserves. There might be a greater risk of bank runs, however, and commercial lenders might face a shortage of deposits
In short, there is much confusion in elite financial and policy circles about the value and future role of cryptocurrencies. Which is probably why as part of its report, the BIS explains the key considerations central banks will need to keep in mind as they create central bank cryptocurrencies, or CBCCs, as a "new form of central bank money". Here is the brief summary:
Our starting point for defining CBCC is a report on cryptocurrencies published in 2015 by the Committee on Payments and Market Infrastructures. This report sought to provide a definition of the new class of currencies represented by bitcoin and altcoins (alternatives to bitcoin) that had emerged using the same technology. The report identifies three key characteristics of cryptocurrencies: they are electronic; are not the liability of anyone; and feature peer-to-peer exchange.
Cryptocurrencies utilise distributed ledger technology to allow remote peer-to-peer transfer of electronic value in the absence of trust between contracting parties. Usually, electronic representations of money, such as bank deposits, are exchanged via centralised infrastructures, where a trusted intermediary clears and settles transactions. Previously, peer-to-peer exchange was restricted to physical forms of money.
Some - but not all - of these features are also common to other forms of money (Graph 2, left-hand panel). Cash is peer-to-peer, but it is not electronic, and it is a central bank liability. Commercial bank deposits are a liability of the bank that issues them. Nowadays, they are in electronic form and are exchanged in a centralised manner either across the books of a given bank or between different banks via the central bank. Most commodity monies, such as gold coins, may also be transferred in a peer-to-peer fashion but are neither the liability of anyone nor electronic.
It may seem natural to define CBCCs by adapting the CPMI's definition to say that they are electronic central bank liabilities that can be used in peer-to-peer exchanges. But this ignores an important feature of other forms of central bank money, namely accessibility. Currently, one form of central bank money - cash - is of course accessible to everyone, while central bank settlement accounts are typically available only to a limited set of entities, mainly banks. In this spirit, Bjerg (2017) includes universally accessible (ie easy to obtain and use) in addition to electronic and central bank-issued in defining the new concept of central bank digital currency (Graph 2, right-hand panel).
The BIS then goes further, and unveils what it dubs "a new taxonomy of money", whose properties are as follows:
- issuer (central bank or other);
- form (electronic or physical);
- accessibility (universal or limited);
- transfer mechanism (centralised or decentralised, ie peer-to-peer).
The BIS then summarizes the various aspect of this new taxonomic definition in the following Venn diagram: the four-ellipse version, which it calls the money flower, shows how the two potential types of CBCC fit into the overall monetary landscape.
The BIS explains:
In principle, there are four different kinds of electronic central bank money: two kinds of CBCCs (the shaded area) and two kinds of central bank deposits. The most familiar forms of central bank deposits are those held by commercial banks - often referred to as settlement accounts or reserves. The other form is, at least in theory, deposits held by the general public. Tobin (1987) refers to this form as deposited currency accounts (DCAs). So far, central banks have generally chosen not to provide DCAs.
While there is much more in the full report (link), the BIS uses the above taxonomy to classify different examples of money from the past, present and future according to where they would fit in the money flower.
The money flower with selected examples
Graph B fills out the money flower with examples of money from the past, present and possibly the future.
Starting at the centre, we have Fedcoin, as an example of a retail CBCC. The concept, which was proposed by Koning (2014) and has not been endorsed by the Federal Reserve, is for the central bank to create its own cryptocurrency. The currency could be converted both ways at par with the US dollar and conversion would be managed by the Federal Reserve Banks. Instead of having a predetermined supply rule, as is the case with Bitcoin, the supply of Fedcoin would, much like cash, increase or decrease depending on the desire of consumers to hold it. Fedcoin would become a third component of the monetary base, alongside cash and reserves. Unlike Bitcoin, Fedcoin would not represent a competing, private "outside money" but would instead be an alternative form of sovereign currency (Garratt and Wallace (2016)).
CADcoin is an example of a wholesale CBCC. It is the original name for digital assets representing central bank money used in the Bank of Canada's proof of concept for a DLT-based wholesale payment system. CADcoin has been used in simulations performed by the Bank of Canada in cooperation with Payments Canada, R3 (a fintech firm), and several Canadian banks but has not been put into practice.
In Sweden, the demand for cash has dropped considerably over the past decade (Skingsley (2016)). Already, many stores do not accept cash and some bank branches no longer disburse or collect cash. In response, the Riksbank has embarked on a project to determine the viability of an eKrona for retail payments. No decision has yet been taken in terms of technology (Sveriges Riksbank (2017)). Hence, the eKrona is located on the border between deposited currency accounts and retail CBCCs.
Dinero electrónico is a mobile payment service in Ecuador where the central bank provides the underlying accounts to the public. Citizens can open an account by downloading an app, registering their national identity number and answering security questions. People deposit or withdraw money by going to designated transaction centres. As such, it is a (rare) example of a deposited currency account scheme. As Ecuador uses the US dollar as its official currency, accounts are denominated in that currency.
Bitcoin is an example of a non-central bank digital currency. It was invented by an unknown programmer who used the pseudonym Satoshi Nakamoto and was released as open-source software in 2009 along with a white paper describing the technical aspects of its design (see Box A for further details).
PokéCoin is a currency used for in-game purchases in the Pokémon Go game and an example of a virtual currency.
Utility Settlement Coin (USC) is an attempt by the private sector to provide a wholesale cryptocurrency. It is a concept proposed by a collection of large private banks and a fintech firm for a series of digital tokens representing money from multiple countries that can be exchanged on a distributed ledger platform (UBS (2016)). The value of each country's USC on the distributed ledger would be backed by an equivalent value of domestic currency held in a segregated (reserve) account at the central bank.
The Bank of Amsterdam (the Amsterdamse Wisselbank) was established in 1609 by the City of Amsterdam to facilitate trade. It is often seen as a precursor to central banks. A problem at the time was that currency, ie coins, was being eroded, clipped or otherwise degraded. The bank took deposits of both foreign and local coinage at their real intrinsic value after charging a small coinage and management fee. These deposits were known as bank money. The Wisselbank introduced a book-entry system that enabled customers to settle payments with other account holders. The Dutch central bank was established in 1814 and the Bank of Amsterdam was closed in 1820 (Smith (1776), Quinn and Roberds (2014)).
The 1934 series gold certificate was a $100,000 paper note issued by the US Treasury and used only for official transactions between Federal Reserve Banks. This was the highest US dollar-denominated note ever issued and did not circulate among the general public. It is an example of non-electronic, restricted-use, government-backed, peer-to-peer money.
Examples of privately issued local currencies include the Bristol Pound and BerkShares, located in the right-hand petal. Stores in Bristol, United Kingdom, give a discount to people using Bristol Pounds, whereas BerkShares are purchased at 95 cents on the dollar and are accepted at retail stores in the Berkshires region of Massachusetts at face value.
Precious metal coins are examples of commodity money. They can be used as an input in production or for consumption and also as a medium of exchange. This is in contrast to fiat money, which has no intrinsic use. Although commodity money is largely a thing of the past, it was the predominant medium of exchange for more than two millennia.
E-gold account holders used commercial bank money to purchase a share of the holding company's stock of gold and used mobile phone text messages to transfer quantities of gold to other customers. Payments between e-gold customers were "on-us" transactions that simply involved updating customer accounts. E-gold ultimately failed. But before it shut down in 2009, it had accumulated over 5 million account holders. Many current private mobile payment platforms, such as Venmo (a digital wallet with social media features popular with US college students) and
M-pesa™ (a popular mobile money platform in Kenya and other East African countries), employ a similar "on-us" model. Users transfer either bank deposits or cash to the operator, who gives them mobile credits. These credits can be transferred between platform participants using their mobile devices or redeemed from the operator for cash or deposits. The daily number of M-pesa transactions dwarfs those conducted using Bitcoin. However, in terms of value, worldwide Bitcoin transfers have recently overtaken those conducted on the M-pesa platform (Graph 1, right-hand panel).