No matter how much you know about central bank digital currencies (CBDC), chances are you’ve heard something about their most serious threats: disintermediating banks and facilitating monetary surveillance and censorship.
From papers to blog posts, a lot has been said on how a CBDC would deprive banks of deposits because funds could be easily moved to CBDC accounts or wallets, especially in times of crisis. Similarly, we’re frequently reminded that a CBDC could be used as an instrument of control because CBDC transactions would be traceable in real time. But will these risks emerge because of CBDCs, or can they materialize regardless of any CBDC ever being issued?
Take bank disintermediation first. The main fear is that too many depositors will move to the safety of the digital currency provided by the central bank, reducing the amount of funding available to commercial banks. After all, CBDCs will be issued by an institution that cannot fail, and most people will be willing to accept them for their nominal value.
Marcelo M. Prates, a CoinDesk columnist, is a central bank lawyer and researcher.
If central banks never issue CBDC, the risk of bank disintermediation disappears, right? Wrong. We already have alternatives to bank deposits that could greatly reduce banks’ funding if used extensively.
And I’m not thinking here about the risk of people converting deposits into cash, which, although possible, can never be simple or fast. Have you ever tried to withdraw $5,000 without giving advance notice to your bank? I’m talking about the possibility of converting money from your bank account to a safer option of digital money that is currently available: e-money or its unregulated twin, the stablecoin.
From the European Union or the United Kingdom to Brazil, e-money issuers, such as TransferWise UK or PayPal Brazil, work like narrow banks: They keep your deposit 100% backed by assets. These companies are legally required to keep the money they receive from their clients safeguarded or insured so that e-money balances are always redeemable at par, with no loss of value. As they are licensed and supervised entities, customers know that, aside from gross regulatory failure, their e-money is safe.
For the countries where e-money issuers can keep users’ funds safeguarded directly with the central bank, like Brazil and, more recently, the United Kingdom, the perception of safety is even stronger. So much so that researchers at the International Monetary Fund named this model “synthetic CBDCs.”
A similar idea is behind the stablecoin model, which promises the virtues of cryptocurrencies built on a blockchain without the price swings. Unlike bitcoin, traditional stablecoins are backed by assets that help maintain their parity to a sovereign currency, usually dollars. Something like money market mutual funds whose shares are easily transferable.
The stablecoin model is more popular in the United States, perhaps because no federal statute has been enacted regulating e-money. Facing the lack of a national “fintech charter,” stablecoin issuers are subject to state money transmitter laws and end up regulated by 50 different state authorities.
The crucial question is whether state regulators are doing a good job in supervising stablecoin issuers-turned-money transmitters, especially regarding the segregation of clients’ funds and the integrity of the assets used for backing. In all U.S. states where regulators follow stablecoin issuers closely to ensure some degree of consumer protection, issuers can claim their stablecoin should be considered as safe as any e-money found in other countries.
Safer alternatives to bank deposits already exist in many jurisdictions. So why haven’t we seen a “digital run” from bank accounts to these options? First, most prepaid cards and accounts come with limits on maximum balances that can be held at any given time because of anti-money laundering rules.
Second, even in countries where fully identified prepaid accounts have no balance limits, like Brazil, people and businesses may still see bank accounts as a more convenient option. The combination of deposit insurance and easy access to other financial services incentivizes you to keep money with a bank rather than with a fintech providing payment services.
Because central banks won’t create a CBDC that facilitates money laundering and criminal activity or offer accounts with credit and investment services, the risk of bank disintermediation because of CBDCs tends to be low – or at least not higher than the risk that exists today with e-money and stablecoins.
Let’s take a look now at the risks of surveillance and censorship created by CBDCs. Sure, abusive governments could use the unique features of a CBDC, notably traceability, to discriminate or censor certain activities or individuals. If, moreover, CBDCs were kept deposited directly at the central bank, governments could even threaten their citizens with balance freezing and confiscation.
These threats should never be taken lightly. But as many in Latin America know, government abuse in monetary matters existed well before any idea of CBDC was even possible. On March 16, 1990, the day after Fernando Collor was sworn in as the first democratically elected president following more than 20 years of military rule in Brazil, he announced the infamous plan to “kill inflation”: the Collor Plan.
Among other measures, the Collor Plan determined that all bank balances above the equivalent of $1,500 would be frozen for 18 months and paid back in installments after that period. Despite the evident arbitrariness of the decision, banks complied with the order and neither the legislature nor the judiciary immediately rose against it.
It was a legal and institutional failure only partially redeemed two years later, with the impeachment of Fernando Collor and his subsequent resignation to avoid the Senate trial that could have led to his removal.
The unfortunate Brazilian tale illustrates that monetary abuse won’t result from the launch of a CBDC. This kind of abuse, like many others against individual rights, is typical of countries with a weak rule of law, incapable institutions and no political accountability.
It may be of little consolation to know that many challenges and risks posed by CBDCs are, in fact, old and can become real even in the absence of a CBDC. But it should be clear that CBDC, by itself, won’t be the root of all evil.