The last few months has seen an array of central banks announce intentions to develop digital currencies, most likely in response to Facebook’s proposed launch of its own stablecoin, Libra.

It would be an understatement to say that the governments, regulators and banks were spooked by the idea of a private company of Facebook’s scale issuing a global digital coin and exerting such influence on the world’s financial system.

However, Johan Javeus believes that central bank digital currencies (CBDCs) would present problems of their own which need to be addressed.

If a central bank was to circulate its digital currency direct to consumers, anybody wishing to use it would have to hold some sort of account with the central bank putting it in competition with commercial banks to hold people’s cash.

“Say the Swedish central bank issues a digital currency,” Javeus says. “Does that mean that every family and business will have an account with the Riksbank?”

This would create an awkward standoff between central banks and commercial banks, which, according to Javeus, could cause a crisis in the financial system.

“Suddenly there is a question of stability in the system,” he adds.

“Of course, everybody will just rush to put their money in the central bank, which would drain capital from traditional banks.”

Without the capital of customer deposits, commercial banks would be less able to provide loan to businesses and mortgages to consumers, which would naturally have damaging knock-on effects on economies.

Centralise or decentralise?

The question though is whether it would be in central banks’ interests to take this approach in circulating its digital currency.

The Bank for International Settlements (BIS) has recently appraised the differing routes that central banks may take in developing and launching a digital currency, describing this direct CBDC or “retail model” as “attractive for its simplicity”, given that central banks would not be dependent on commercial banks as intermediaries.

However, this model requires central banks to build the necessary infrastructure to deal with the regulatory burdens relating to KYC and AML, as well as more rudimentary tasks relating to customer service, system outages and so on.

“This would be a huge project for a central bank to undertake,” Javeus states.

“There are a lot of potential problems that would need to be straightened out, and we don’t know yet how these would be addressed.”

Therefore, it may be more likely that central banks will adopt an approach which uses commercial banks and other intermediaries as conduits for circulating, outsourcing the aforementioned burdens to them in the process.

This 'wholesale model', however, comes with the downside of the central bank being reliant on intermediaries for information relating to individual claims on the currency. This would bring various supervisory and regulatory processes that exist in different forms as part of the system we have at present.

Libra to the rescue?

This being the case, it seems more likely that central banks would follow a ‘hybrid model’ in developing a digital currency, which combines elements of the other two. The BIS proposes that this would involve a central bank distributing the currency, with intermediaries like commercial banks handling retail payments. However, the central bank would periodically record retail balances to exert a greater deal of control than in the wholesale model.

The hybrid model then has the advantage of being simpler for the central bank to offer, but at the cost of requiring a more complex infrastructure. The likelihood is then that central banks would turn to technology companies with the capabilities to provide this.

This may suggest that there is hope for Libra yet. Central banks will be aware that Facebook can deliver the infrastructure required for a digital currency to function at a sufficient scale far better than they can.

“I don’t think central banks have quite decided how they will go about it, because of these potential problems in issuing a digital currency,” Javeus says.

Painful as it may be then, central banks may decide their best bet is to work with Facebook to bring some form or Libra to market and use it as the basis for their own digital currencies.

Javeus adds: “Facebook and its peers are huge companies with resources and know-how at their disposal that far exceed that of any central bank.

“So, if Facebook are able to clear the regulatory hurdles and get the go-ahead to launch Libra, it would be difficult for central banks in any country to compete with such a currency.”

Central banks may then decide that they would rather have Facebook and other Big Tech companies inside the tent spitting out, than outside spitting in.

See the Finextra long read on Libra, CBDCs and more at Welcome to the era of stablecoins.