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Cryptocurrency is dead. Long live Central Bank Digital Currency!

A much more intelligent person than me once saidthat cryptocurrency is “everything you don’t understand about money combined with everything you don’t understand about computers.” This makes me feel dangerously under-qualified writing this post, but it’s worth having a go, right?!

A colleague that I have a lot of time for recently asked me what my view on banks and cryptocurrency was. As a Product Director for Payments at a B2B2X SaaS Fintech called Currencycloud, he probably assumed that I was laden with lofty ideas on this topic. The reality is that I’m a lot closer to the definition above.

“Banks are terrified of cryptocurrency,” I answered.

Why? Because if cryptocurrency to me is everything I don’t understand about finance multiplied by everything I don’t understand about technology, then it may be a safe assumption to say that there are other people in Fintech and Banking who also don’t fully get it.

The Fear

Surely banks can’t be scared of crypto?! Well, fear is caused by a threat to your current reality. For many banks, their current reality is of power, market dominance, and profit. If any or all of those are threatened, it generates the innate “fight or flight” response. But for a bank to fight the threat of crypto, they need a deep understanding of cryptocurrency, which at least according to John Oliver means an understanding of both “money and computers”. While banks may understand money, they may not get the inner technical workings of crypto. Acquiring that deep technical understanding of how cryptocurrency works is expensive, and an activity that may not generate enough of a return on an investment at this stage. Industry expert Chris Skinner stated back in 2015that blockchain was 10 to 20 years away from being mainstream in Financial Services. A 20 year ROI is hard for even the most persuasive people to sell.

This is, of course, a broad brush stroke of a position that doesn’t reflect every bank: JP Morgan’s JPM Coin and Interbank Information Network as a permissioned variant of the Ethereum blockchain are perhaps the most obvious exceptions to this rule. But for the most part, banks are terrified of cryptocurrency because the only protection mechanism they have to this emerging threat is through flight, not fight.

(There is also the parallel counter-argument that banks shy away from cryptocurrencies because they are intangible assets that banks have to deduct from their balance sheets, which in turn reduces confidence in them as a credit institution, but this also verges beyond my scope of knowledge, and perhaps of this post too.)

The Change

There is a change underway though. But it’s not towards cryptocurrency. It’s towards the technology that underpins cryptocurrency.

Central Bank Digital Currencies (or CDBCs if you want to sound swanky) are emerging around the world at a rapid rate. Trials are in place, with central and commercial banks working together to understand how this new technology fits within the financial world they already know. The concept has been directly influenced by crypto technology, and is already being trialled and tested in various proof of concept models globally.

But if banks are terrified of cryptocurrency, why are they not afraid of CBDCs?

I think it comes down to two reasons:

  1. Trust: CBDCs are just a digital representation of fiat money, and fiat is something that you and me and the average person in the street already trust (at least in most countries). And we trust it because it’s backed by central banks and governments and protected by regulation.
  2. Power: CBDCs are created — and therefore controlled — by central banks, who in turn retain the power that comes with societies trusting in and relying upon that fiat currency. And once you have that power, that’s not something that policy makers and authorities want to let go of easily.

Cryptocurrencies decentralise: they strip that power away from the central and commercial banks and governments alike. In contrast, CBDCs centralise: they retain that power, perhaps even reinforce it.

But some would also argue that without state backing, without institutions and authorities to regulate a currency, people would lose that trust in that very medium of exchange. Perhaps the trust of the people and the power of the institutions who govern those people are two sides of the same coin (pun absolutely intended). But if they are, then you have two forces essentially moving in the same direction, which is not towards cryptocurrencies, but towards state-backed and -regulated digital currencies using similar technology and principles from which cryptocurrency has emerged.

If we all accept for a moment that in most developed economies we trust in fiat currency, and will likely continue to do so for the near future, we must also accept that we trust that the people and institutions who manage and regulate fiat currency are doing this successfully. (If they weren’t, we would already have lost that trust and have moved to other mediums of exchange.) By trusting these people, we are in turn accepting that these people understand money and the complex financial systems.

It would be no big jump for us to also extend our trust to digital fiat currency (CBDCs) that is built on technology that we perhaps individually don’t understand, but that is built by people who have the combined understanding of money and technology. After all, if we can place our trust in a Great British Pound coin or a US Dollar bill without understanding the financial processes underpinning them, or in trillion-dollar tech companies without understanding the technology on which they run, why can’t we do the same when it comes to digital currency?

The Evolution

And by that train of logic, I find myself comfortable with the fact that Central Bank Digital Currencies will be integral to the next evolution of financial technology. That next evolution is already underway, and is about the integration of financial services outside of the Financial Services industry itself. We’ve seen other industries and people’s lives transformed through digitalisation (shopping with Amazon, travelling with Uber, searching with Google). The evolution of payments will allow non-financial companies to embed truly digital services into their apps and websites, in turn making the experience and journey that bit easier, faster, cheaper or more tailor-made for the likes of you and me. CDBCs will be a key enabler for this journey.

If CBDCs do help businesses embed financial services at a deeper level than previously before, and if that then allows customers like you and me to do more for less in our busy everyday lives, this will only help increase the trust that we all have in CDBCs. And by increasing our collective trust in a digital proposition that simultaneously is controlled by the institutions in whom we already trust, in future this will only widen the gap between Cryptocurrency and Central Bank Digital Currency.

Avid crypto supporters and investors will no doubt disagree. But next time I’m asked my opinion on banks and cryptocurrency, I’ll probably have a more definitive answer:

Cryptocurrency? No chance! It’s all about CBDCs — Central Bank Digital Currency.

 

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Comments: (5)

Chandra Shekaran
Chandra Shekaran - Tata Consultancy Services - Bangalore, India 31 August, 2020, 12:151 like 1 like

The crypto-currency was dead on arrival was what I always thought; apart from speculative use cases, the real proposition to switch customer adoption to this currency form apart from other compliance reasons, there was no way that a crypto could make it. However, while CBDC will definitely come by and will compound the complexity and complexity in the beautiful world of payments

Christopher Williams
Christopher Williams - RTpay - Winchester Uk 31 August, 2020, 15:471 like 1 like

I agree crypto-currencies are primarily for (high risk) investment, while CBDCs can establish digital transactions across the whole payment landscape.

It is a case of where will they develop first and to best use; that should be in developng countries, particularly where relatively low levels of the population have bank accounts. 

An ideal test case for such central banks is in the acceptance of remittances, which are already well-regulated but where the costs are far too high.

CBDCs can assist in bringing costs down to below the SDG 3% target, something that is urgent as the pandemic-based recession is causing such turmoil in this important area of aid.  

A Finextra member
A Finextra member 01 September, 2020, 13:451 like 1 like

CBDC have the power to replace or substantially change the existing payment services. At the same time they are either the ultimate tool for money laundrers and terrorist financiers or the realisation of an orwellian world where Big Brother will know everything you do with money. In order to stop money laundry to explode the central bank issuing the currency need to maintain an identified audit trail on every currency unit. Do not believe that the GDPR will protect you - surely the central bank audit trail will be exempted from data protection rights of the population. No more income tax declarations, no more VAT statements, the tax office will through AI pick everything up from the central bank currency pool and also charge your "wallet" directly by withdrawing digital currency from you. No more private consumption - the central bank will see all your spending and can send you to the AA or to gambling anonymous! Banks as we know them today will cease to hold deposits causing 100% of the mortgages and loans to be refinnaced on market terms and most likely increase the cost of borrowing. Payments will also move away from banks when the deposit account is replaced by a central bank DC wallet or virtual central bank account. The change is likely to be painful to society as all revolutions are and have unintended consequences. In the future somebody manages to clone the central bank monies in spite of acid proof block chain technology and it will be discovered as inflation or at worst as a collapse of the currency in question. To trust the "authorities" with all the payment info and the entire payment system is not prudent risk management. 

Christopher Williams
Christopher Williams - RTpay - Winchester Uk 03 September, 2020, 07:061 like 1 like

I would like to comment on the last lengthy statement; while I somewhat understand the anticipated 'Big Brother' aspect of CBDCs, I don't see this as the way they would be applied in democratic countries.

Our work involves the usage of CBDCs primarily to increase efficiency of delivering funding to those most in need, starting with family remittances that continue to be subject to excessive fees. Enabling these funds to flow through CBDC accounts, to everyone who does not have a bank account, can cut the costs to zero. The funds are delivered into mobile payment accounts, or through vouchers, or - as in India with great success - to new bank accounts which offer a lead into full banking services.

In short, CBDCs can easily be limited as to the size and duration of funds held there, with all such funds convertible at par into domestic accounts of any type.

I accept the process needs to be watched  by those who remain suspicious, but the reality is, particularly during these Covid-related recessionary times, we need to cut costs, improve delivery of all forms of aid and encourage all new forms of payments, but from an integrated, secure source. 

Prasoon Mukherjee
Prasoon Mukherjee - Societe Generale Bank - Bangalore 08 September, 2020, 16:461 like 1 like

You must share your thoughts more often Piers. Everything you have written is correct, and so will this space emerge in not so distant future.

While CBDs are on the horizon and will be a reality sooner than we can contemplate, the critics in this space must realize that emergence of CBDs, and they being on a blockchain, doesnt necessarily mean the death of regulators or central banks.

CBDs and Central banks will coexist for a long tim.. And all of responsibilities related to macro economic rebalancing, issuance of CBDs, regulating rates and thereby attempting to control inflation will still be the onus of central banks.

In other words, what it means is that while emergence of CBDs doesnt mean the death of centralized governance by central banks, however CBDs will still come soon enough to bring in efficiencies in settlement cycles, cost of circulation, and interbank reconciliations.

Piers Marais

Piers Marais

Product Director (Payments)

Currencycloud

Member since

05 Sep 2017

Location

London

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This post is from a series of posts in the group:

Banking Strategy, Digital and Transformation

Latest thinking in respect to Banking Strategy, Digital and Transformation. Harnessing our collective wisdom to make banking better. Ambrish Parmar


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