The Deputy Governor of the Bank of Jamaica (BOJ), Natalie Haynes, has put its work on CBDCs in the context of the government’s financial inclusion strategy. The BOJ sees a CBDC as an important tool in allowing people to access financial services and products.
The Bank of Jamaica Act is being amended to that a CBDC is legal tender so that merchants can accept it with confidence since, unlike cryptocurrencies or stablecoins, CBDCs are backed by the central bank.
The BOJ will pursue a two-tier approach working with licensed deposit-taking institutions and payment service providers (PSPs) to issue the CBDCs. The BOJ has a FinTech regulatory sandbox where a number of PSPs are currently working.
The CBDC will be usable through E-money wallets, card networks or other digital options. The requirements to get a wallet for those currently without a bank account will be easier and simpler without the same onerous requirements of ‘Know Your Customer’ requirements needed to open a bank account. People will need a networked mobile device to download and use CBDCs through an app (or over the phone). They will be able to upload money using authorised agents or smart ATMs.
Like cash, it will earn no interest and will only be usable for domestic transactions. The BOJ believes it will make it easier for small business to borrow from the formal banking system based on their credit history which is now visible to the banks.
The BOJ is planning to roll out its CBDC platform in the first quarter of 2022. At the moment there is only one commercial bank on board, the National Commercial Bank, who were part of the pilot. Further deposit taking institutions are expected to sign up prior to the roll out.
The European Central Bank (ECB) Occasional paper 286 ‘Central Bank Digital Currency: functional scope, pricing and controls’ by Ulrich Bindseil, Fabio Panetta, Ignacio Terol investigates concerns that the introduction of a CBDC, if not properly designed, could lead to undesirable bank disintermediation and crowd out private payments solutions.
On 1 October 2021 the ECB started a two-year investigation into a digital euro project. The goal is for a digital euro that works as a medium of exchange at scale without becoming a significant means of investment. Ironically a digital euro must work for transactions, an area which is not the usual operational role of a central bank, but not work too successfully as a safe store of value, a safe haven role which central banks are famous for.
An advantage the ECB has, of course, is that it is not motivated by profit. It does not need, or want, to capture market share and establish a dominant market position. Central banks can seek broad access to its CBDC without displacing payments intermediated by regulated institutions at the aggregate level or in any specific segment.
To succeed a CBDC must be accepted by merchants and intermediaries must be happy to distribute it and interact with the users of CBDCs. Both individuals and firms must choose to use it for payments. How ill central banks incentivise front front-end service providers?
When defining the design of a CBDC, a long list of functions can be created, for example,
(i) Be usable for transactions based on cards, mobile payments and desktop access
(ii) Allow anonymous payments
(iii) Allow offline payments
(iv) Allow instant credit transfers to any commercial bank account and direct debits
(v) Be programmable and allow “smart contracts” for advanced uses in industry and commerce
(vi) Promote financial inclusion for those without bank accounts, mobile phones or internet access)
(vii) Be available for international uses strengthening the international role of the currency.
The goal often promoted is that a CBDC should not crowd out the private sector is scope. There are those who argue for a broad functional scope, that it is safe to allow very significant investments in a comprehensive CBDC, at least in large currency areas. They argue that an excessively narrow scope could make a CBDC insufficiently attractive and lead to low demand so the potential benefits would remain unachieved.
People who prefer a narrower functional scope argue this could minimise the dangers of crowding out the private sector. Pursuing a broad-scope CBDC makes the design and introduction harder and riskier, and this may delay the introduction of a CBDC. There are plenty of payment projects that ultimately did not take off for reasons that could not easily have been foreseen.
The ability of the central bank to improve the existing payment options for consumers, merchants and intermediaries depends on actions taken by others and reconciling initially conflicting interests. The paper argues three conditions are necessary for success,
1. Legal tender status, to support effective merchant adoption; this requires defining what exactly legal tender implies in a digital context and whether and how other payment solutions may benefit from the standard it generates
2. Incentives for supervised intermediaries; this requires an understanding of how their cost and revenue structure may be affected by various fee/compensation structures
3. Demand from consumers to pay with CBDC and a way to identify the transactions for which CBDC is likely to be used, without becoming invasive.
Designing an effective cost recovery and fee/compensation structures requires reconciling challenging demands, the need to allow costs to be recovered while possibly also identifying a public-good factor, aligning compensation structures of existing private sector solutions, including balancing this with the cost recovery and fee approach taken by central banks for banknotes, ensuring welfare objectives are taken into account and achieving a market share that provides volume without dominating.
One of the major benefits promoted for CBDCs are cross-border and foreign exchange payments. As a result, this paper pays particular attention to this area.
The paper concludes that many questions about the design of a CBDC still need to be addressed including the functional scope, business model and controls required to meet demands and ensure robust use. Any CBDC project has also to be kept realistic, manageable and focused.
The Governor of the Bank of Tanzania (BOT) has said that BOT has started preparations to have its own CBDC.
The Governor of the Central Bank of Nigeria said that there were 600,000 downloads of the country’s digital currency, the eNaira, in less than four weeks after its launch. The central bank is keen for people without smart phones to adopt the e-Naira.
The ECB’s new supervisory framework designed to assess the security and efficiency of electronic payments includes companies enabling or supporting the use of payment cards, credit transfers, direct debits, e-money transfers and digital payment tokens, including electronic wallets. Crypto-asset related services will be included.
This approach is designed to complement EU regulations that are being brought forward covering crypto assets such as stablecoins and international standards for global stablecoins. The new rules will apply to companies already regulated by the ECB from November 2022. Other companies will have a year from when they are told they are subject to oversight to comply.
The crypto services include merchants who accept crypto assets within a card payment scheme along with the option to send, receive or pay with crypto assets using an electronic wallet.
In June 2021 the Basel Committee on Banking Supervision issued proposed rules on investments in crypto assets by financial institutions. The proposals required banks to have sufficient capital reserves to cover any losses on bitcoin holdings in full. This requirement is currently in place for the highest risk investments.
A joint letter was submitted in response to the proposals by the Global Financial Markets Association, Financial Services Forum, the Futures Industry Association, the Institution of International Finance, the International Swaps and Derivatives Association, and the Chamber of Digital Commerce. The associations requested and argued for a revision to the proposals because, as written, they effectively preclude banks from getting involved in crypto assets by making it economically prohibitive. The Committee will work to produce a new consultative document by mid-2022.
In a separate announcement the Committee also agreed to consult on a set of principles for the effective management and supervision of climate-related financial risks at internationally active banks.
These will include potential measure covering disclosure, supervision and regulatory measures to address climate-related financial risks to the global banking system. This work follows on from the publication of a series of analytical reports earlier this year.
India is said to be planning to ban private crypto currencies. The news has caused a sharp drop in Bitcoin prices in India and is the result of a bulletin on the Indian parliament’s website announcing a plan to legislate to ‘prohibit all private cryptocurrencies in India’. The same legislation will allow ‘certain exceptions to promote the underlying technology of crypto currency and its uses’ in order to ‘create a facilitative framework for creation of the official digital currency to be issued by the Reserve Bank of India’.
A group of Japan’s private banks and companies have announced plans to test a private digital yen. Work has been underway on the project since last year and the plan is for it to be backed by bank deposits and to use a shared platform, although with a separate ‘business process area’. The idea of the separate is to allow the currency to be programmed to meet the different needs of the participants, an important requirement given the diverse back grounds of the 74 companies involved.
A range of different user cases are being considered including as the purchase of clean energy, retail payments, industrial settlements and Non Fungible Tokens.
The group do not rule out the CBDC being planned and implemented by the central bank. Proof-of-concept work is set to begin soon ahead of a full launch in the near future.
Decentralised Finance (DeFi) is the name given to using software run on blockchain to do what traditional intermediaries did on the conventional infrastructure. A new report by Elliptic, a company that helps its customers make the crypto economy a safe place to transact and invest, says the DeFi theft and crime is largely because the technology is still ‘immature’.
When decentralised apps are poorly designed and developed then hackers can exploit the mistakes. It estimates $10.8 billion was stolen in 2021 because of bugs being exploited with a further $1 billion the result of where an app creator has deliberately left a ‘backdoor’ in the code so that they can steal user funds or the theft of ‘admin keys’.
The strength of decentralised apps lie in the elimination of third-party control of user funds, although this is undermined if the creators of the protocols make mistakes or are dishonest. The difficulty of tracing end users in a decentralised, global system brings unique challenges to regulators.
The former Bank of England deputy governor for financial stability Jon Cunliffe observed ‘Even on an initial view it is clear that the sector is opaque, complex and undertakes financial activities that carry risk - activities that are regulated with the traditional financial sector. There are pronounced market integrity challenges given the absence of investor protection, AML and other market integrity provisions.’ The report says the technology will need to mature and become better-regulated if DeFi is to become a real alternative to the current financial system.
The Turkish lira is sharply down in value this year, over 40%. On 24th November Bitcoin hit a new all-time high after the lira dropped 15% on the news of President Erdogan defending the reduction in interest rates in Turkey at a time of 20% inflation. In Venezuela bitcoins can be used to pay for fast food, in department stores and at the airport as a reaction to the country’s hyperinflation.
On 23rd November India revealed plans to bank cryptocurrencies, resulting in bitcoin’s price falling 14.8% on the major Indian exchange WazirX. Bitcoin’s price fell worldwide but not as much as in India.
The Reserve Bank of India (RBI) forced banks not to do business with crypto firms for several years until the Supreme Court overturned that policy in March 2020. The RBI continues to regard cryptocurrencies as being bad for macroeconomic and financial stability, hence reintroducing a bill to outlaw private cryptocurrencies while creating a legal framework for a CBDC.
Foreign exchange (Forex) trading is an area where central banks regard cryptocurrencies as a risk. Exchange controls are used to limit inflows and outflows of currency. If currency is turned into cryptocurrency, then these restrictions are avoided. People who chose to do this are taking big risks in the hope of making big returns. Forex trading can be volatile since money can swiftly move driven by sentiment alone.
If institutional investors start to see cryptocurrencies as useful for storing value, a way of hedging against inflation, then incidents of forex trading and the risk of high-volume capital flight increases. Central Banks are concerned about consumers losing their savings but systemic risk is even higher on their agendas.
