IBM/OMFIF Report on Central Bank Digital Currencies

Recently, I ran across this web page describing a report issued jointly by IBM and the OMFIF last fall (September 2018). This blog article will feature this report in some detail because it is a pretty comprehensive summary of where things stand in terms of central banks looking into using central bank digital currencies (CBDC's). 

I obtained a copy of the full report by providing a name and email address so I assume anyone can do the same if they want a copy of the report. Since they ask for that information to receive the report, I won't provide a direct link to the pdf version of the report, but will extract a few excerpts below for some analysis and comments. 

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Below I have pulled out a few excerpts from the report to give you a feel for it. The report is laid out in six main sections. Below I excerpted a comment from the summary of each of the six sections with my analysis (if any) just below the excerpt. Below that I tried to list some bullet point observations from the report. One point of interest to me is that on page 22 of the report, we find these comments under the title "Digital Tokens as Reserves" (I added underlines for emphasis).

Digital tokens as reserves 

(from page 22 of the IBM/OMFIF report):

"The impact on monetary policy would further depend on whether the digital tokens in question have the status of reserves. As one respondent put it, "If these tokens are considered as reserves, and the blockchain system is a new medium for recording transactions, then there should be no impact on monetary policy, and the existing tools may continue to be used.’ Around 80% of survey respondents shared this opinion. 

In today’s system, the International Monetary Fund’s aspiration for its special drawing right to become a global reserve currency has been held back by conflicting geopolitical interests and priorities of the reserve-issuing central banks of the US, euro area, China, Japan and UK. CBDCs can circumvent such hurdles by enabling the private sector to work directly with the central banks to create a digital SDR to use as a unit of account and store of value. 

Such an e-SDR would be the quintessential reserve asset, because it would be fully backed by the reserve currencies in the IMF- determined ratio. The supply of e-SDRs would in turn be dependent on market demand. This would require the creation of a sufficiently large e-SDR-denominated money market."

Readers here may recall that this concept is one we have mentioned here before quite some time ago, so it's interesting to me to see it talked about in this report. The report does not say that the IMF is currently testing an "e-SDR" (see further comments below). Also, it's interesting to note that the report says "the supply of e-SDR's would be dependent on market demand". This fits in with the currency board rules proposal of former IMF Dr. Warren Coats that we recently covered here that issues currency based on market demand.

Now lets look at some excerpts from the six major sections of the report.

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Section 1 - Defining CBDC's

"A WHOLESALE central bank digital currency may lead to significant improvements in efficiency, speed and resilience, as well as lower the cost and complexity associated with existing payments systems."

. . . .

"Central banks concluded that blockchain systems must improve before they can overcome issues of scalability and speed."

My comments: Wholesale means that the currency would be issued to banks but not the general population (which would be a "retail" CBDC). This report concludes that a wholesale CBDC is far more likely than a retail one based on input from the central banks they surveyed. A wholesale CBDC woud not represent significant change from the present system in my view.

Section 2 - Technology Considerations


"A WHOLESALE CBDC would have to preserve the existing capabilities of RTGS (Real Time Gross Settlement) systems without significant degradation. The system must also preserve confidentiality of payment transactions, the ability to pay interest, monitor compliance against regulatory reserve requirements, change the composition of participants and run liquidity savings mechanisms."

. . . .

"The challenge that remains for the main vendors of wholesale CBDC systems is to construct a convincing RTGS replacement that can be properly benchmarked against existing systems and meet the high standards for security, robustness, efficiency and speed."

My comments:  This section lays out the technology challenges for any central bank that may want to think about implementing a CBDC system. It mentions several including privacy issues for partcipating banks and security against cyber attacks.


Section 3 - Praticalities

"CENTRAL BANKS addressed critical design and technological questions, including who will have management responsibility, what a possible design of a wholesale CBDC would look like, and how new systems will interoperate with legacy ones."

. . . .

"Overall, respondents underscored that wholesale CBDC research and trials are still in their infancy, and that doubts remain over DLT’s ability to deliver on its promise."

My comments:  This last sentence is consistent with what we have reported here for some time and also with the recent update from BIS General Manager Agustin Carstens that we featured here.


Section 4 - Policy Implications
 (I added underline below for emphasis)

"THE BROAD regulatory and policy implications of a potential wholesale CBDC depend on design and management choices, such as whether it would be backed by a single sovereign currency or a basket of assets.

Based on survey responses, the likeliest outcome is a central bank-issued, fiat currency-backed digital token. This would have no significant monetary policy implications."

. . . .

"A wholesale CBDC could be expanded to serve as a digital global reserve asset along the lines of the International Monetary Fund’s special drawing right. This would have profound geopolitical and regulatory implications."


My comments:  Lots of interesting information in this section. First, note how most central banks preferred a "fiat currency-backed digital token". This is in contrast to the proposal of Dr. Warren Coats who prefers to anchor a currency to a basket of goods. Next, this section is where the reference to the concept of an "e-SDR" comes from (detailed on page 22 of the report and quoted above). Also note that the report states this (an "e-SDR" as a reserve currency) "would have profound geopolitical and regulatory implications". I believe this is because of the intense political debate that would go along with a proposal to adopt some kind of "e-SDR" as a digital global reserve asset and the fact that the US and other reserve currency issuers prefer the status quo at this time. Especially the US with the US dollar as the primary global reserve currency.

Section 5 - Case Studies
 (I added underline below for emphasis)

"OMFIF'S CASE studies span a range of projects. They include exploratory endeavours, such as the European Central Bank and Bank of Japan’s Project Stella, as well as more developed undertakings, such as the Bank of Canada’s Project Jasper."

. . . .

"The studies cover a range of technological choices, from platforms built on Linux’s Hyperledger Fabric to Ethereum. Various capabilities such as smart contracts and liquidity saving mechanisms were examined."

. . . .

"None of the central bank case studies examined included the possibility of radically overhauling their payments systems in the near future. Most are satisfied with existing RTGS platforms."


My comments:  This section looked at several case studies of actual central bank trials around the world. Please note that the last paragraph underlined above again confirms what we have reported here on this blog for some time.


Section 6 - Conclusion
(I added underline below for emphasis)

"Achieving real-time gross settlement (RTGS) for domestic and cross-border payments has traditionally been fraught with complexities, high costs and lengthy settlement times, leading to several risks in settlement finality. Central banks agree that, despite significant improvements in existing structures, these issues continue to undermine payments systems. Maintaining overall system resilience is a priority for central banks, especially as the current system remains vulnerable to single points of failure. The main motivations expressed by central banks in pursuing a wholesale central bank digital currency include potential improvements in speed, efficiency and resilience, as well as boosting system utility as non-cash assets become tokenised. However, realising these benefits depends on the success of the underlying technology.


Trials of wholesale CBDC systems illustrate how variations of distributed ledger technologies have the capacity to meet and, in some cases, exceed the performance of existing interbank systems. However, there is still a long way to go before the technology is mature enough to meet central banks’ expectations for the next generation of real-time gross settlement systems.

. . . .

"The next step would be to produce a pilot programme and move actual capital. A central bank could, in a controlled environment, issue a legal liability to a participant, have it transferred to another participant, then have it redeemed. DLT experimentation focusing on the interoperability of ledgers in cross-border payments should follow.

Collaboration between private sector participants and the central bank will determine whether these initiatives find success domestically. For cross-border success, this collaboration must expand to include various national central banks from around the world."

Readers can click here to find the OMFIF web page related to this report

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My final added comments: This report is consistent with what has been reported here for some time on this topic. While there are constantly news articles suggesting that major changes by central banks or the IMF are imminent in regards to converting to either central bank digital currencies or even an "e-SDR" at the IMF, this report clearly lays out where all this really stands as of last fall when it was issued. IBM is at the very forefront of this and I view them as a high credibility information source. 

My take is that while all of this is being studied and discussed, as noted above, most central banks do not see this kind of change happening any time soon and only after a lot more research takes place. Even then, the report states there is no guarantee that central banks will move in this direction (unless convinced there is a clear operational advantage for them to do so).

It also does not say the IMF itself is close to moving in this direction with an "e-SDR". It does mention the idea of an "e-SDR" as a concept for a global reserve currency though. Input I get from experts on this suggests to me that this article is not talking about the official SDR used at the IMF, but rather a private version of the SDR based on the component makeup of the currency basket of the actual SDR. We will cover this more in depth in a follow up article next week.

The IBM/OMFIF report does not really clarify exactly what they mean as I read it, but they mention private sector entities working with central banks to "create" this "e-SDR" as they call it. This suggests something other than the official SDR used at IMF.

In addition, one expert on the SDR that I hear from reminded me that changes in the existing rules for SDR's at the IMF must be approved by the membership and that the US has veto power in the voting at the IMF. Also, while the IMF could promote the issuance of private SDR's (not official SDR's), there is no indication that the IMF is looking into doing that at this time based on input I received that I view as highly credible.

This is a topic to keep an eye on over time, but right now there is no indication that something major is about to change in the current monetary system unless some kind of new major crisis forced an emergency decision to make changes as we have been reporting  here for some time.

Short OMFIF video summarizing the report

WSJ - Have You Heard of IMF Coin?

The Wall Street Journal now runs this article that once again talks about things we have been covering and talking about here for some time. Below are some excerpts.

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Forget Bitcoin. Have You Heard of IMFcoin?

IMF would like its special drawing rights to have a digital future, and has spent the past year thinking of a broader role for it

"Forget Bitcoin, think IMFcoin. The head of the International Monetary Fund has been musing about the future of money, and thinks there is a decent chance it will come from the guardian of the world’s monetary system.

Christine Lagarde, IMF managing director, held up the organization’s special drawing rights (SDRs) as having a possible digital future at a Bank of England forum last week, and put what she said was a “question mark” over whether SDRs could replace existing international currencies. “It’s not a far-fetched hypothetical,” she said, and the IMF needs to be ready."

. . . .

"There is little chance U.S. politicians will want to give up what a French finance minister once called the “exorbitant privilege” of the dollar, no matter what Ms Lagarde, another former French finance minister, might suggest. (note: this comment is from the author of the WSJ article, the following sentence is attributed to Director Lagarde and the bold emphasis is mine) As she noted, the IMF would need a “geopolitical situation that would be propitious” for the changes she is speculating about to happen."

Please click here to read the full WSJ article

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My added comments: I will just point out again that all this is something we have talked about here for some time now. This older article and this very recent article are examples.

At this point maybe I should explain what prompted me to write on this topic since it is now appearing in mainstream media and seemingly everywhere. I first began to think about this idea when I saw a demonstration presentation (see this video) that talked about the idea of an asset backed cryptocurrency that could be used by banks and central banks (and perhaps even the IMF) in the existing system some day. I began to to research this concept and discovered that the idea of using the SDR in a different way than it is used currently outside the IMF has been discussed at times over the years. I learned that even now there are so called "private SDRs" outside the IMF that can be used. However, these are not official SDR's used by IMF member nations. Instead they are more like someone simply owning an investment in the 5 currencies that make the current SDR basket in the same ratio as they are used in that basket. Not really an SDR and certainly not any kind of legal tender currency of its own. An 'SDR denominated bond' has to eventually be converted back into some kind of national legal tender currency to utilize the funds in the private sector.

But thinking about the concept, it seemed like it could be possible some day for the IMF to consider using the SDR in a new way (more like a real currency anyone could own) and that the new technologies arising in the fintech arena might be considered as part of that process. Also, I have followed Jim Rickards now for many years and he has never wavered in his prediction that the SDR would likely be put forward as a potential replacement for the US dollar in the next major global crisis which he also predicts will eventually arrive.

All this led me to dig into the topic of the SDR and try to find as much accurate information on it as I could in the event these forecasts do pan out. I created this page on this blog to archive what I could find and have written about here.

These articles include a lot of direct input from Dr. Warren Coats who at one time was the head of the SDR Division at the IMF. I am pretty sure you will not find a more informed expert on the SDR anywhere on the earth than Dr. Coats. 

I have always wondered and also speculated about whether the IMF might some day consider a "digital version of the SDR" given all that I mentioned above. Now we have IMF Director Lagarde talking about it openly in a public speech and this article in the Wall Street Journal discussing the idea. I feel like this is confirmation that the topic is important (as I have tried to emphasize here for some time) and that the information that has been presented here is pretty accurate as best I could make it. I don't claim to be an expert, but I have been fortunate to get direct input from some people who I do view as experts. 

So, a question that may arise is if I believe this is going to happen and also if it will be a good thing if it does happen. The only honest answer I can give is, "I don't know", to both questions. I don't have any reason to believe right now that we are close to some kind of digital version of the SDR (blockchain based or not) that would replace the US dollar. As far as I know, while we now can confirm the idea of a digital version of the SDR has been at least mentioned by Director Lagarde, there is no indication that the mechanics to actually implement such a thing currently exist at the IMF. 

To get to that point, all kinds of things would need to happen that have not yet happened as far as I know:

- the IMF would have to have some kind of system in place that could implement using the SDR in this way. This is a formidable task and would require a lot of testing etc. As far as I know, nothing has even been started along those lines (although some individual central banks are heading in that direction)

- changing the way the SDR is used like this would require approval of the IMF member nations

- the US retains veto power over any votes taken at the IMF along these lines

-  the only public statement I know of from the IMF on this is that they are currently studying whether or not to promote a broader role for the SDR in the monetary system. 

- no public report on this study has been released as far as I know

- the best information I have is that perhaps next year the IMF may go forward with some kind of promotion for broader use of the SDR based on their internal research, but as far as I know, that would more likely be the "private SDR" mentioned above and not the official SDR used by member nations

One statement that Director Lagarde is quoted as making in this WSJ article did catch my attention (in bold underline below):

"There is little chance U.S. politicians will want to give up what a French finance minister once called the “exorbitant privilege” of the dollar, no matter what Ms Lagarde, another former French finance minister, might suggest. As she noted, the IMF would need a “geopolitical situation that would be propitious” for the changes she is speculating about to happen."

That last sentence attributed to Director Lagarde is almost word for word what we have said here now for quite some time. We have said that absent a new major global crisis, these kinds of changes are more likely to take place over a long time period because of the difficulty in getting global cooperation from individual central banks beholden to their own countries and because the political will to make these kinds of changes does not appear to be present at this time. We speculated that under  severe crisis conditions, things could possibly change and lead to faster consideration of these kinds of changes. This statement attributed to Director Lagarde seems to confirm that analysis as best I can tell.

As to whether this kind of change would be good or not, I have no idea. I know that Dr. Warren Coats has a proposal on the table to use the SDR in a new way and we have covered that here extensively. I feel completely confident that Dr. Coats is deeply concerned that any kind of proposal to use the SDR as a global reserve currency be based upon strict rules (Currency Board rules) that would not allow the SDR to simply be created at will by the issuer (and likely stimulate inflation). If the SDR is proposed as a global reserve currency some day, I do hope that the proposal Dr. Coats has put forward will be the basis for such a plan because I know he has put years of study into the idea and understands that a currency must be stable in value over time to serve the public well.

All kinds of other questions have been raised such as whether the SDR should be fully or partially backed by gold for example. The IMF does own gold reserves so they could do that (but I think gold would need to be at a higher price). Dr. Coats prefers to see a basket of goods used rather than just gold because he believes that would be more stable over time.

I certainly do not know what would work best or if any of this will actually ever happen. The goal here is to try and accurately inform and educate readers on this topic so that whatever opinions they form will be based on accurate information. Some day a proposal to do this (use the SDR as global reserve currency) may be put forward. It is better to understand this topic than to not understand it if that day ever does arrive. I see a lot of misinformation on this topic for sure, so I try very hard to get the information presented here as accurate as I can. You can review all the information archived on this blog page.

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Added note: I had several experts review this article and no significant changes were suggested to me.

CNBC runs this article on the same topic.

Christine Lagarde - IMF Should Be Open to Considering a Digital Version of the SDR

In this new speech at the Bank of England in London, IMF Director Christine Lagarde asks the audience to fast forward to the year 2040 to see what the world of central banking might look like. Interestingly, most everything she talks about in this future look has been covered here on this blog for some time. Below are some excerpts and then a few added comments.

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. . . . 

"And much has changed for the bankers and policymakers here in the City of London. But that is only the beginning. Let us spin the hands ofBig Ben forward to 2040 to catch a glimpse of their world. We might see that:

· Cars have disappeared, because people are moving about in hovering drones, or “pods,” which elegantly avoid each other in the morning rush hour.

· One of those pods carries the central bank governor, who recently started her second term. As part of her morning routine, she swipes through a hologram of news videos curated by a digital assistant, before arriving at Threadneedle Street.

· The governor disembarks, walks up to the columned façade, opens the door and…

Who will she encounter inside the building? Are there economists sitting at desks, debating policy choices around a table? Or is there an intelligent machine making decisions, setting rates, and issuing money?

In other words, how will fintech change central banking over the next generation? That is the focus of my remarks today."

. . . . 

"Let us start with virtual currencies. To be clear, this is not about digital payments in existing currencies—through Paypal and other “e-money” providers such as Alipay in China, or M-Pesa in Kenya.

Virtual currencies are in a different category, because they provide their own unit of account and payment systems. These systems allow for peer-to-peer transactions without central clearinghouses, without central banks.

For now, virtual currencies such as Bitcoin pose little or no challenge to the existing order of fiat currencies and central banks. Why? Because they are too volatile, too risky, too energy intensive, and because the underlying technologies are not yet scalable. Many are too opaque for regulators; and some have been hacked.

But many of these are technological challenges that could be addressed over time. Not so long ago, some experts argued that personal computers would never be adopted, and that tablets would only be used as expensive coffee trays. So I think it may not be wise to dismiss virtual currencies."

. . . . 

"So in many ways, virtual currencies might just give existing currencies and monetary policy a run for their money. The best response by central bankers is to continue running effective monetary policy, while being open to fresh ideas and new demands, as economies evolve."

. . . . 

"Instead, citizens may one day prefer virtual currencies, since they potentially offer the same cost and convenience as cash—no settlement risks, no clearing delays, no central registration, no intermediary to check accounts and identities. If privately issued virtual currencies remain risky and unstable, citizens may even call on central banks to provide digital forms of legal tender."

. . . . 

Cooperation is key

"To make things smoother—at least a bit—we need dialogue. Between experienced regulators and those regulators that are just beginning to tackle fintech. Between policymakers, investors, and financial services firms. And between countries.

Reaching across borders will be critical as the focus of regulation widens—from national entities to borderless activities, from your local bank branch to quantum-encrypted global transactions.

Because of our global membership of 189 countries, the IMF is an ideal platform for these discussions. Technology knows no borders: what is home, what is host? How can we avoid regulatory arbitrage and a race to the bottom? This is about the IMF’s mandate for economic and financial stability, and the safety of our global payments and financial infrastructure.

The stakes—and gains—from cooperation are high. We want no holes in the global financial safety net, however much it gets stretched and reshaped.

I am convinced that the IMF has a strong role to play in this respect. But the Fund will also have to be open to change, from bringing new parties to the table, to considering a role for a digital version of the SDR.

In other words, the IMF is in for the pod-ride."

. . . . 

Conclusion

As our pod journey comes to an end, some of you may wonder about my upbeat tone. For many, this new world of central banking is less Mary Poppins, and more Aldous Huxley: a “brave new world,” much like the one described in Huxley’s famous novel.

I believe that we—as individuals and communities—have the capacity to shape a technological and economic future that works for all. We have a responsibility to make this work.

That is why I prefer Shakespeare’s evocation of the brave new world in The Tempest: “ O wonder! How many goodly creatures are there here! How beauteous mankind is! O brave new world .” 

Please click here for the full speech text

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My added comments: It's interesting to see Director Lagarde talking about the future of virtual currencies in ways similar to what we have talked about here. When we first wrote about this concept (a central bank or IMF digital currency everyone could own), it seemed like there was not much talk about it anywhere else that I could find. But now we see it pretty much everywhere. While it sounded very strange at first, perhaps it will turn out like things we saw on the original Star Trek TV series a long time ago and assumed were just figments of some writer's imagination and would never really show up in the real world. Director Lagarde mentions the year 2040 in her speech.

I am pretty sure that the one paragraph in this speech that will get a lot of attention is this one:

"I am convinced that the IMF has a strong role to play in this respect. But the Fund will also have to be open to change, from bringing new parties to the table, to considering a role for a digital version of the SDR."  (bold emphasis and underline is mine)

And we have talked about this very thing here for a long time. We have even pointed out that in order for the SDR to be used in this way in the future, the IMF will have to approve changes in the status quo (Director Lagarde says "be open to change").

While many will leap on this to assume that a new blockchain based SDR is waiting in the wings ready to be launched very soon, I do not believe this to be the case. As we have said here many times, something like this is possible in the future. We have a full page of articles archived here over the past several years that talk about this kind of thing. 

But the best information I have suggests that this process is likely to unfold gradually over a long time frame (unless a new major global crisis forces events to move more quickly). Note that in this speech Ms. Lagarde talks about the year 2040. That timing might be a bit long, but probably closer to reality than the idea that in the next year we will see a new blockchain based digital SDR launched. Absent a crisis, this is the way I can see this unfolding over time:

2018 - we see the first central bank digital currency launched (perhaps in Singapore)

Following this, we might see some other smaller central banks follow suit and issue central bank digital currencies in what we might view as trial runs to see how well the technology functions in the real world and how the public accepts it.

Next three to ten years - more and more individual central banks adopt central bank digital currencies (depending upon how well the trial runs turn out). Some of the major central banks come on board during his phase.

After all this (if it actually happens), we might then see the IMF think about trying to implement some kind of digital version of the SDR if central banks around the world have been successful in their efforts with central bank digital currencies. 

I think the IMF is more likely in the short run to look for ways to get broader use of the SDR and to promote the use of the so called "private SDR" as first step. The private SDR is not widely used at this time around the world and the official SDR can only be used within the IMF structure.

The IMF has a lot of questions to continue to study in regards to the SDR and of course any significant change to the way the official SDR is issued needs approval by IMF member vote. The US continues to hold veto power over any such votes taken at the IMF.

This time table could speed up of course. It might move faster on its own or another major crisis could force some kind of global monetary conference where major changes might be agreed to in response to the crisis. But, absent such a crisis, I think it is more realistic to look at these kinds of changes as taking place over many years starting with a few central banks testing out central bank digital currencies first.