How is the great CBDC experience going?

Anton Dzyatkovsky

CEO and co-founder of Platinum Software Development Company. Blockchain enthusiast, blogger.

In March 2022, Joe Biden formally asked the Federal Reserve (FED) to urgently begin developing plans for a US central bank digital currency (CBDC), or so-called “digital dollar”. The U.S. government is now beginning to recognize the latent opportunities in the booming digital asset market and hopes to use this technology to create a CBDC that will “preserve the dominant role of the U.S. dollar.” But what is a CBDC? What is the connection with cryptocurrency and what are the latest developments in the great CBDC experiment?

What is a CBDC?

The FED defines a CBDC as “a digital liability of a central bank that is widely available to the general public.” The “digital” part is not so innovative in that most people already hold money in a digital form in one way or another, such as commercial bank accounts. The particularity of a CBDC lies mainly in the fact that it is a central bank liability rather than a classic commercial bank liability.

When a person holds money in a commercial bank, the commercial bank itself has an obligation to “pay” on demand and exchange the digital record of the money for physical money. However, in a fractional-reserve banking system like ours today, banks have a limited pool of assets to meet these obligations and they must rely on mechanisms such as deposit insurance to maintain consumer confidence and avoid bank runs. Therefore, the “digital currency that is the responsibility of a commercial bank comes with great systemic instability.” At any time, an event can scare off consumers.

People line up around the block to get U.S. dollars from an ATM in St. Petersburg, Russia, March 8, 2022.

For a CBDC, the issuing central bank is the institution with an obligation. Unlike commercial banks, a central bank has a monopoly on increasing the monetary base, and therefore owning a CBDC results in far fewer trust-related vulnerabilities and no obligation to maintain an underlying asset pool. since the central bank could always issue more CBDCs. A CBDC is therefore “analogous to a digital form of paper money” because it can be used without “credit or liquidity risk”.

While acknowledging the huge successes and “explosive growth” of digital currencies like Bitcoin, the president expressed concern about the risks of unregulated crypto-assets to “consumer protection, financial stability, national security and [the] In hopes of mitigating these risks, as well as “harnessing potential benefits” to “strengthen American leadership in the global financial system,” Biden has asked federal agencies to explore the creation of an American CBDC.

How does this relate to the rest of the crypto industry?

Despite these recent announcements from the US administration, the FED is late to the CBDC part. In a BIS article, published in January 2021, 56 out of 65 central banks surveyed were engaged in some sort of CBDC development. One of the main motivations for central banks to pursue research in this area is the [payment] implications” of CBDCs. The FED acknowledged that current cross-border payments “remain slow and costly”. Improving cross-border payments relies on the full use of “new technologies”, which is where private crypto companies come in.

Developing a CBDC isn’t the only form of payments modernization that could bring improvements. A white paper written by an Arab Monetary Fund advisory group listed 3 alternatives, including improvements to messaging protocols, coordination of existing RTP (real-time payment) systems, and the use of cryptocurrencies.

Messaging protocols include providers such as SWIFT, Revolut and RippleNet which essentially increase the efficiency of the old fashioned correspondent banking model where banks use their deposits in different countries to transmit funds through a chain of intermediaries to the recipient final.

“RTP systems coordination” is the approach taken by providers such as The Clearing House and is based on promoting cross-border interoperability between national instant payment systems.

Finally, although typically used more often as a speculative investment, specialty cryptocurrencies designed as a payment solution, like Ripple XRP, have the potential to bypass the entire legacy payment system. They function as standalone currencies that can be instantly transmitted between digital wallets across national borders.

Image credit: blokt

These potential solutions are important to note because, to put it simply, CBDCs could well become redundant if any of these alternative forms of payments modernization are adopted by traditional financial institutions. For example, major banks like Wells Fargo and JP Morgan are already adopting new RTP systems and the FED white paper even called The Clearing House’s RTP network a successful “real-time interbank payment system”. Likewise, if the court rules in favor of Ripple in a now infamous SEC lawsuit, then XRP may face fewer hurdles to widespread adoption.

So where are we now?

CBDCs are by no means faltering despite stiff competition in the FinTech arms race. Perhaps the most promising recent development for future CBDCs is the Dunbar Project paper, titled “International settlements using multi-CBDCs,” published by the Bank for International Settlements in March 2022. In this paper, the BIS outlines its latest project that aims to create a digital currency platform that “would facilitate cross-border transactions between financial institutions”. They have already successfully developed 2 working prototypes, including Patior.

I’m very optimistic about this if you dig into my article exploring the uses of blockchain technology in modern monetary policy, you can probably find:

“The use of blockchain technology…in state monetary policies can be implemented by issuing a digital currency that can become an alternative to the current dollar settlement system.”

While the potential for CBDCs is debatable, it is worth asking whether we should be skeptical of the idea of ​​government-backed CBDCs and whether they would align with general cryptocurrency ethics.

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