New digital currency pushes banks to address technology-based risk


The first cryptocurrency transaction in history was feted in just two words: “Running Bitcoin”, which came in the form of a tweet on January 11, 2009 by Hal Finney, a US software developer. Some 10 years and over 1600 initial coin offerings later, the world of crypto-, virtual and other digital currencies looks to have provoked an active response from financial sector leaders. However, this was sparked not by an entity with an established cryptocurrency profile, but by social media giant Facebook. In June 2019 the company introduced its digital currency Libra, promising a launch date in 2020. Central banks and global institutions spent the previous decade watching the development of alternative currencies, but are now taking action after Facebook’s announcement. They have made it clear that they perceive digital currencies as a threat to economic stability, and argue that having a leading technology company participate in the financial services landscape exacerbates that risk. According to Jerome Powell, chairman of the US Federal Reserve, Facebook’s size and global reach would make Libra an instant and systemic risk.

Growing Momentum

In January 2019 the Bank of International Settlements (BIS), a Switzerland-based organisation of central banks, stated that most central banks were “not seeing the value’’ in creating their own digital currencies. However, two weeks after the Libra announcement, Agustín Carstens, general manager of the BIS, announced that multiple central banks were working on issuing their own digital currencies, and that the BIS is offering technical advice on how to do so. According to a BIS survey published in 2019, more than two-thirds of the 63 banks surveyed were considering creating central bank digital currencies (CBDCs). While most of the banks have not explicitly stated that the goal of their offering is to crowd out Libra, the European Central Bank has more directly said it plans to establish its own digital currency in response to the Libra proposal. It is not yet clear whether digital currencies from the public and private sectors would be in direct competition – that depends on whether central banks design theirs with wholesale, or retail, banking in mind. Nonetheless, they appear ready to take on the risks inherent in moving outside their regulatory comfort zone – even as the Libra project has lost some steam due to the perceived challenges of getting approval from regulators. “This is risky business,” Martin Chorzempa, a research fellow at the Peterson Institute for International Economics, a non-profit think thank based in Washington, DC, told OBG. “If CBDCs do not work, the credibility of the central bank could suffer.”

Leadership in CBDCs has thus far come from Sweden, where the Riksbank’s e-krona is a key part of that country’s strategy to abandon paper money; and from China, where the People’s Bank of China has been working on a digital currency that, as of early 2020, was “progressing smoothly”, according to the central bank. Another innovator is Tunisia, which already has a digital currency, the e-dinar, established by the national postal service, and whose central bank is also considering a CBDC. Furthermore, in Indonesia, where Bitcoin is tradeable but banned for payments, Agus Martowardojo, governor of the Bank Indonesia, said in early 2018 that a digital rupiah issued by the central bank could be a year or two away; however, no further announcements had been made as of February 2020.

Gauging Interest

Meanwhile, some central banks are sticking with the BIS’ previous position that issuing their own digital currencies is not necessary. These include the central banks of the US, Singapore and the Philippines, the latter of which is a key player in global financial flows due to its position as the fourth-biggest recipient of global remittances. In these countries, the likely approach to alternative currencies will be regulation. “We have to be open to innovation [while at the same time maintaining responsibility to the] consumer,” Benjamin Diokno, governor of Bangko Sentral ng Pilipinas, told local press in July 2019. Many have noted that in places that are already open to financial innovation – such as Kenya, the first country in which mobile money platforms were available – regulatory approaches often require technology companies to partner with banks. In Mexico the central bank believes there would be no demand for CBDCs unless users are ensured anonymity, though that could aid money-laundering and other illicit financial flows. “At one extreme, full anonymity [and] protecting user privacy may facilitate the execution of illegal activities,” Javier Guzmán Calafell, deputy governor at Banco de México, said in a speech in July 2019. “At the other end, perfect traceability may hinder interest in CBDCs from users who, for personal and perhaps completely legitimate reasons, prefer to keep part of their transactions unrecorded.”


Digital currency is the umbrella term for all crypto- and virtual currencies, and experts do not agree on what type of digital currency Facebook and its partners are proposing, nor how it should be regulated. Juan Castañeda, a senior lecturer in economics at the UK’s University of Buckingham, told OBG that Libra would allow its users to make payments and transfer money. Banking regulators, however, see it as a financial services product that should be regulated as banking products are. This would require Facebook and its partners in the project to shoulder some of the same responsibilities as banks, such as active and ongoing customer due diligence to avoid money-laundering and other illicit financial flows. From the perspective of the US Securities and Exchange Commission, the currency should be classified as a security because it could deliver investment income to its partners. Though Facebook has said that it is flexible on the details, it is likely Libra will not be a floating currency like Bitcoin. The initial plan included pegging Libra’s value to a basket of conventional currencies, likely large and stable ones such as the dollar, euro and sterling. For each Libra in circulation, there would be a unit of these currencies held in an account called the Libra Reserve. This has led some to call the Libra a stablecoin, since the value of the Libra would not likely drop below the value of the conventional currencies underlying it. It would bring specific benefits to the countries whose currencies are in the basket, in the form of increased foreign exchange demand, and a motivation to keep its value stable. “Central banks would have an incentive to maintain the value of their currencies, because they would want Libra to use them,” Castañeda told OBG.

Blockchain Tweak

The Libra also stands out from Bitcoin in how it proposes to use blockchain technology. Bitcoin has helped to popularise blockchain as a permissionless system, in which participation and execution are transparent. For Libra, however, only those with permission are able to view the electronic data trail and track its activity. Access would be limited to members of the Libra Association, a not-forprofit group to be based in Geneva, Switzerland. These entities would then serve as an intermediary that can access the ledger, exchange Libra for hard currencies and offer customers digital wallets in which to store their Libra. The association initially had 28 members, including payments companies, venture capital firms, blockchain companies, telecommunications providers and non-profit organisations. However, by October 2019 the group had shrunk to 21, as Mastercard, Paypal and others decided to end their involvement. Holders of Libra would not earn interest on balances held in their digital wallets, like they would with conventional money held in a bank account, but would gain flexibility in international payments and benefit from lower fees and faster transfers. This would leave the Libra Reserve with a pool of capital it plans to invest in low-risk instruments such as government bonds. These would earn a return on investment, which would be used by the Libra Association to cover costs. Anything left over would accrue to its members. This structure gives Libra sufficient similarities to a pooled investment fund, which triggered the US Securities and Exchange Commission’s review to determine whether it should regulate aspects of the new currency offering.

Fast Response

While central banks have responded to Libra by speeding up their deliberative processes around crypto-, digital and other alternative currencies, and by considering offering their own versions, it is not clear that CBDCs would be a natural competitor or alternative to a proposal like Libra, Castañeda said. “Libra would mostly be a payment system,” he told OBG. “Whereas Bitcoin is a new currency that stands on its own and is a competitor.” This suggests that, regardless of what central banks have in mind or intend to react to, a CBDC does not have to be a response to only Libra, and may not be meant for as widespread of use as Libra. Rather, they could be complementary products. Central bank pilot projects such as those in Saudi Arabia, the UAE and Thailand have focused on using CBDCs in the wholesale banking market to ease flows between banks rather than between people, and in systems in which only banks can use them.

CBDC Benefits

With a number of central banks now looking at establishing their own CBDCs, a basic set of arguments has emerged for and against the concept. Some do not apply to all countries, or do not apply with equal force. Venezuela and Iran, for example, see CBDCs as a way to cope with US sanctions that prevent them from fully participating in the current global payments system. This is different to Sweden’s cashless motivation for issuing a CBDC. Still other central banks envision CBDCs as a general control mechanism rather than a purely financial one, namely the People’s Bank of China, which views it as a tool to preserve control over the digital economy, and potentially one for surveillance.

For most, however, arguments for a CBDC generally include preserving control over monetary and economic stability in the way central banks have always done, promoting financial inclusion, and making cross-border financial flows faster and cheaper. To the IMF, CBDCs are seen as a way to promote financial inclusion in emerging markets, as mobile access to a digital currency could be easier for people in remote places or those facing language barriers. It is with this goal in mind that Tunisia introduced its e-dinar.

For Saudi Arabia and the UAE, a digital currency might help speed up the process of moving money across borders. In January 2019 the Arabian Peninsula neighbours announced a pilot project for a digital currency called Aber. As of February 2020 details on its progress had not been made public, but the proposed model seeks to address the wholesale market, allowing banks to use Aber to facilitate financial settlements. According to Chorzempa, there are multiple ways CBDCs could speed up financial flows while making them cheaper. “It is basically ‘programmable’ money,” he told OBG. “There can be smart contracts in which payments between counterparties could be automatically triggered by certain conditions.” Tax collectors could use this technology as well, such as by creating automated payment systems for value-added taxes as goods clear Customs, eliminating bureaucratic hassle on both sides of the transaction.

CBDC Drawbacks

The promise of CBDCs is matched by the risks they could engender, such as loss of monetary policy control, privacy and security issues, and the decline of cash as a counterweight. Existing cryptocurrencies can offer a lesson here: there is significant demand for cryptocurrencies as an investment or an asset class to be traded by investors, but their use as a way to pay for goods or services has been far more limited. This could suggest low retail demand for CBDCs as well. For example, the Ethereum blockchain platform handles an average of 15 transactions per second, compared to Visa’s global platform, which handles approximately 24,000 per second. Concerns over whether CBDCs could erode central bank control over monetary policy are currently being discussed. If more business is transacted via digital currencies, that reduces the role of conventional banks as a financial intermediary, which in turn reduces the role of benchmark interest rates on loans from central banks to conventional banks. Interest rates are the core tool of modern monetary policy that enables central banks to promote stability in their economies. However, some analysts have suggested these fears may be overblown. One way to reduce risk while still having CBDCs as a retail option would be to forbid consumers from holding actual accounts at the central bank, and establish intermediaries to do this instead, just as conventional banks do for fiat currency. In a similar vein, the Libra Association is planning to offer its users digital wallets instead of allowing them direct access to the system.

Regulatory Checks

An e-wallet provider would be in charge of performing important regulatory functions such as anti-money-laundering and know-your-client checks. This kind of oversight presents a its own risk for privacy and security breaches. “Facebook promises that sending money would be as easy as sending a text message, but they do not have to do customer background checks for that,” Heike Mai, a Frankfurt-based banking analyst for Deutsche Bank, said. “You cannot just ask people to click a box to accept terms and conditions. You have to monitor your clients. But if they can do that, I do not see a big problem.” The same regulatory responsibilities would apply to central banks that issue CBDCs and allow direct retail access. The BIS has raised concerns that digital currencies could lead to a more direct presence of the world’s biggest tech firms in the financial services industry, which it believes could undermine the banking sector and economic stability. Even though some of the world’s largest banks have failed to meet their regulatory responsibilities at times, they remain a partner that central banks have relationships with and know how to regulate, Teunis Brosens, lead economist for digital finance and regulation at the Netherlands’ ING Bank, told OBG.

Combined Effort

Central banks’ willingness to experiment with digital currencies has seen greater momentum as big tech firms express interest in entering the financial services sector. For now it remains unclear whether CBDCs can or will fully replace, or eliminate the need or desire for private sector digital currencies. Nevertheless, given that the global infrastructure for cross-border payments needs to be updated, blockchain and other new tech could play a role, Brosens said. Regardless of how the future landscape for digital currencies pans out, it will require the combined expertise of private firms and central banks.

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