The Bank of England (BOE) has been busy this year looking into an idea that we have actually written about here on this blog. A little over a year ago we published this article that talked about the idea of a new (possibly digital) global reserve currency that anyone could own and use. Even before that we talked about a company involved in a pilot project in the South Pacific that had developed a potential asset backed cryptocurrency that could be used by central banks and/or the IMF some day.
Now we have direct evidence that this idea is really being studied at the Bank of England. Earlier this year BOE Deputy Governor Ben Broadbent made a speech talking about the very kind of digital currency concept we had in mind. This month the BOE released a new research paper on the pros and cons of actually implementing a Central Bank Digital Currency. Both the speech and the research paper talk about it being possible to issue such a currency that you and I could own and not just banking entities. Below are some excerpts from the speech and paper on this followed by some added comments.
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from the March 2016 speech by Ben Broadbent:
"Acting as a trusted third party is precisely what a central bank does. It performs that role only for one particular asset, central bank money (i.e. reserve deposits held largely by commercial banks at the central bank). But the function goes right to the heart of what central banks do and how they came about. And if a private-sector digital currency uses the technology to substitute for a third-party clearer, the central bank counterpart would do the opposite. The aim would be to widen access to the central bank’s balance sheet, beyond commercial banks. There’s no rigid correspondence here: in principle, one could introduce the technology and preserve the current arrangements, under which it is commercial banks that hold central bank deposits; it’s also possible to increase the number of counterparties without it. But the distributed ledger would probably make it easier to do so. That might mean adding only a narrow set of counterparties – perhaps a wide range of non-bank financial companies, say. It might mean something more dramatic: in the limiting case, everyone – including individuals – would be able to hold such balances."
. . . .
. . . "However, things do not end there. The point about the new technology is not just that it might make exchanging assets more efficient, to a greater or lesser extent. In principle, it also makes it easier to widen the access to those assets, perhaps dramatically so. If you create a platform on which the existing participants can more easily exchange central bank money, why not extend the right to others?
As I said in the introduction, this certainly isn’t impossible under the current settlement system, known as RTGS (for Real Time Gross Settlement). There are already some non-bank institutions that have access to the Bank of England’s regular facilities8. As my fellow Deputy Governor Minouche Shafik recently explained, the Bank is currently undertaking a review of RTGS and the question of access will be one of the issues involved (Shafik (2016)).
But it seems likely that a distributed ledger would make that process easier, opening up the balance sheet to a wider variety of financial firms. One might go further, giving access to non-financial firms, or perhaps even individual households. In the limit, a distributed ledger might mean that we could all of us hold such balances.
If so, our accounts would no longer be a claim on commercial banks but, like banknotes (Federal Reserve notes in the US), the liability of the central bank."
Now here are some excerpts from the BOE research paper (July 2016)
page 7
For example, in its original
implementation, and still at the time of writing,
Bitcoin is limited to between 7 and 10
transactions per second,
or roughly 3,500 transactions per hour, perhaps sufficient to provide
electronic payment services to a medium-sized town.
Despite this, the real resource cost of
maintaining the Bitcoin network is on the scale of entire national economies. O’Dwyer and Malone
(2014) estimate that the total electricity consumption of the Bitcoin network in early 2014 was
comparable to that of Ireland (roughly 5GW). Deetman (2016) further estimates that, at current
growth rates in computing efficiency and popular uptake, the Bitcoin network could potentially
consume as much as 15GW by 2020, similar to the consumption rate of Denmark in 2014.
On this basis alone, we believe that in order for a digital currency system to be socially beneficial
over the long run, an alternative method of addressing the cheap talk problem in transaction
verifications needs to be developed and adopted.
page 65
Both central banks and private financial institutions are paying increasing attention to the
emergence of digital currencies and the distributed ledgers on which they are based, as this
technology may present an opportunity to improve the efficiency, resiliency and accessibility of
systems that facilitate monetary and financial transactions. There are, however, serious problems
with existing private versions of such currencies.
These problems are not associated with the
viability of distributed ledgers in general, but rather with their prohibitively high costs of
transaction verification. Alternative implementations, such as “permissioned” systems, may
potentially avoid these costs by stepping away from purely decentralised designs while still
retaining many of the benefits.
One possible application of such a permissioned system would be
the issuance of a central bank digital currency (CBDC) — universal, electronic, 24x7,
national-currency-denominated and interest-bearing access to a central bank’s balance sheet.
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This BOE paper includes the possibility that private citizens could own this CBDC and is what they mean by "universal" access above.
From page 11:
"From the perspective of
households and firms, CBDC
would be economically equivalent to the establishment of an online-only, reserve-backed, narrow
bank
alongside the existing commercial banking system and, as such,
would represent an
expansion of competition in the market for deposit accounts. This should again lead to a more
rapid adoption of innovative technologies and account offerings."
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In its conclusion section (p. 66), the report raises several questions for further research:
"Important theoretical questions include the following: What are the welfare properties of
alternative CBDC policy rules, including their interaction with traditional monetary policy rules,
with macroprudential policy rules, and with fiscal policy rules? Should CBDC policy rules also
react to financial variables, rather than simply to inflation as in this paper? What are the
advantages and disadvantages of introducing CBDC into the economy through spending (on
goods/services and/or transfers), lending (directly or via the banking system), or the purchase of
financial assets, including not only government bonds but also other financial assets? Which of
these would best safeguard financial stability? How might the issuance of CBDC interact with the
unwinding of Quantitative Easing? What could be the impact of CBDC on international liquidity
and exchange rate dynamics? How might the introduction of CBDC affect the likelihood of a
bank run when bank deposits carry default risk, or the dynamics of a run if one were to occur?"
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My added comments: We can clearly see that this idea is still in the early research phase. However, this information directly confirms ideas we have been reporting here on this blog for some time including:
- the potential for a future central bank (or IMF) issued digital currency is quite real
- this could even include a central bank (or IMF) reserve currency that individual citizens could own. In the case of the IMF, it could even be a modernized version of the SDR (this would require changes at IMF that would need approval). The Real SDR proposal of Dr. Warren Coats could be implemented quicker and easier which is why he feels it is a more realistic approach
- a private citizen might acquire the central bank digital currency in exchange for an approved asset like a government bond and the currency might also pay interest to the owner per the BOE report
- the idea presented in the BOE report assumes a central bank digital currency would exist "alongside" the other money already in existence now and would not replace it (the BOE paper even assumes cash bank notes would still be used)
- there is no chance that Bitcoin would be adopted by central banks for this purpose because the social cost of running it is too high (as explained by our expert here in a two part blog article last year) and Bitcoin cannot handle enough transactions for use as a payments system on a mass scale
- the blockchain (so called distributed ledger) behind Bitcoin is not likely to be adopted by central banks either in its current form for the same reasons Bitcoin won't be adopted (high social costs and transactions limits)
A "modified distributed ledger" where access is limited to fewer parties is looked at in this BOE research paper, but not the distributed ledger Bitcoin uses (access to everyone). I sent this new research paper to the expert who wrote the Bitcoin/Blockchain article for this blog. He gave a positive reaction to this idea as being feasible, but does not believe that a modified distributed ledger is needed to achieve the benefits sought by the BOE. The technology to do what they are looking at already exists now without using a distributed ledger (or a modified distributed ledger). Low cost real time money transfers, payments, and even cross currency transactions can already be done now.
An asset backed cryptocurrency could easily be integrated into such a system as well to be used as a store of value for anyone who wanted to own it to exist alongside existing national currencies. You could call this new cryptocurrency a bancor, an Ikon, an SDR, a Real SDR, an e-Euro, an e-dollar, or whatever else any central bank that adopted it wished to call it. This cryptocurrency could be officially backed (insured to some level of bank account deposit), anchored to an asset based index, and exchangeable into any other currency in real time using a mobile phone if desired. All that technology exists now without needing any kind of distributed or modified distributed ledger to facilitate the means of payment or record the transaction and still meet existing banking regulations.
While the sources I talk with do not think that anything like this (a central bank digital currency) is on the near term horizon, it is interesting to me to see that we now have official BOE sanction to take a look at this idea.
When I first wrote on this topic, I could find very little official public information on it and relied on sources involved in working with this type of technology behind the scenes.
The PBOC in China is also looking into a central bank digital yuan currency as well, so innovation in the private sector may be forcing central banks to move towards this idea even if the pace is somewhat slow. We will just continue to watch and see what actually happens. Perhaps we will get some interesting news at G20 this September.
Added notes 8-6-16: Zerohedge runs this article reviewing a Wall Street Journal article on central banks looking at digital currencies. The Zerohedge article questions whether such new central bank digital currencies would be abused by central banks to invade privacy and remove the option for people to own cash not controlled by a monitoring system. This will be a point of debate and contention for sure if this moves forward at central banks. Again, Governor Carney at BoE said in his June speech he did not see central bank digital currencies replacing cash any time soon and it's all still in the early study phase at BoE.
