What CBDC Is (Not) About – Part I

Reshaping The Monetary System

Photo by Charlotte Venema on Unsplash

Note: this is the first post of a short series on central bank digital currencies. The second part can be found here.

tl;dr: CBDC is not about technology, digital payments, or programmable money. It's about a prospective power shift from the private to the public sector which, if implemented, has the potential to fundamentally reshape our current monetary and financial systems, with implications not yet fully understood.

The rise of CBDC

On Friday October 2nd, the European Central Bank (ECB) released a new report discussing the potential introduction of a central bank issued digital currency (CBDC) dubbed the 'digital euro'. It's the latest addition to what appears a booming market for thought leadership emanating from the public sector: once an obscure niche topic largely ignored by the establishment, CBDC has quickly become a key policy issue eagerly discussed in a seemingly never-ending stream of reports, articles, and speeches by officials.

News also transpired that the ECB had applied to trademark the term 'digital euro' prior to publication – another sign indicating the importance attributed to the subject. The rapidly-growing popularity of CBDC is no surprise: dire macro conditions, a looming economic depression, and the exhaustion of conventional monetary policy tools are a fertile ground for discussing unorthodox ideas.

Unlike many other reports, the ECB paper largely ignores technological considerations and focuses instead on the key requirements derived from a set of core principles. I think this hits the nail on the head. In this short series, I'd like to lay out what CBDC is really about, and why you should care.

What CBDC is not

First, let's start with what it's not.

CBDC is not something new. The Bank of Finland's Avant smart contract system from the 1990s and the Bank of Ecuador's Sistema de Dinero Electrónico from 2014 were early CBDC implementations. Both have been retired since (is this supposed to tell us something?...).

CBDC is not about the technology. It's amusing how CBDC appears inextricably tied to 'blockchain', or its en-vogue pendant DLT (short for 'distributed ledger technology'). There is no reason at all why DLT should be any more suited than other technologies. In fact, I think there's little reason why a CBDC should run on DLT at all. [1] The early implementations highlighted above took place long before the blockchain hype.

CBDC is not about digitising money and payments. Most money we use is already digital – although 'electronic' may be the more popular word here. The numbers you see in your online banking account? The balance you see on your screen when logging into PayPal? These are interfaces to deposits and other forms of money that are stored electronically as book entries in the systems of payment service providers. Cash – the only physical form of money – represents only a minor share of total money in circulation, as we shall see later.

CBDC is not about programmable money. While there are different interpretations as to what programmable money really means, it seems to boil down to conditional payments: the ability to automatically lock up funds that are only released once certain pre-specified conditions are met. And – surprise! – this is something that already exists today, in virtually every payment system. Now, to be fair, the automatic enforcement of conditionality in today's financial system is mostly limited within the confines of closed, internal systems. There is certainly room for improvement in extending automation beyond enterprise boundaries (i.e. automating workflows between different entities), but that's not the main driver behind CBDC.

This is not to say that all of the above should be dismissed. All I want to say is that these are all secondary considerations, at best.

A power shift with significant implications

So what, then, is CBDC really about?

Irrespective of the exact design and implementation details, CBDC is about a power shift from the private sector (financial institutions) to the public sector (central banks).

In our current monetary system, the public sector has effectively outsourced the creation, management, and distribution of money to the private sector. The intermediation role of the banking and financial sector has turned private credit into the dominant component of the money supply, in all its various forms (bank deposits, e-money, money market fund shares, and now even blockchain-based stablecoins).

By contemplating the provision of a globally-accessible, state-backed alternative to private credit (i.e. a new form of the euro that is a direct liability of the central bank, not the private sector), central banks are paving the way for a fundamental reshaping of the very structure of our current monetary system, with major changes in the composition of the money supply and the role of the financial sector. It's a reshaping that could significantly alter the power balance between the private and public sectors, by expanding the authority and influence of central banks over the creation and management of money at the expense of financial institutions.

Why now?

More than ten years after the Global Financial Crisis, economic prospects remain bleak. The emergence of social movements that blame financial institutions and their role in the monetary system for past excesses and current stagnation have shifted the Overton window. The global pandemic and the ensuing breakdown in global trade have further pushed demands for expanded government oversight and intervention. CBDC is a major instrument in that toolkit. 

In order to appreciate the wide-ranging implications of this power move, we first need to understand how the monetary system works today. That's what the next post in this series will explore.

Footnotes

[1] Multi-party distributed consensus systems are an overkill for arrangements where there are established trust relationships. This doesn't mean that there aren't useful tools and concepts that central banks can borrow from the dynamic DLT ecosystem. Most of "blockchain" is a facade to pave the way for profound changes in infrastructure, processes, and thinking – something we've been saying for a while at Paradigma.