Central Bank Digital Currency is not a race? Tell the rest of the world.
Over the last month, we have discussed stablecoin regulation and Central Bank Digital Currencies (CBDCs). These, and other impending regulations make it clear that the blockchain will grow in application. That said, a regulated cryptocurrency market will grow far slower in the future than crypto did in the past.
Crypto is already having growth issues outside of regulation. Consider this week. Ethereum had a particularly troublesome bit of news. Its long-heralded shift from proof-of-work to proof-of-stake validation has been delayed. This "Merge" delay has been called “Terrible News” by Nasdaq.com.
On top of crypto’s internal problems, the US government is evolving the structure of future regulation at an accelerating pace. This is especially clear with the evolution of stablecoin regulation. The stablecoin market is already adjusting to the coming regulations as stablecoin enters the bank market. This week we continue to explore the impact of a CBDC on the financial system. The use of CBDC is spreading across the globe and I expect that its importance will shortly begin to be felt in the US, despite a reluctant Federal Reserve.
Fed sees little urgency
The Federal Reserve has maintained a cautious and slow approach to a US CBDC. Chairman Powell made the position abundantly clear by reiterating that “China's rush to develop its digital yuan will not push the U.S. into a digital currency race.”. But, on its face, the US is in a global race to create a CBDC whether the Fed likes it or not. The Fed should not underestimate China and other countries as they attack the US’s reserve currency status.
One measure of the growing importance of CBDC is the rising discussion of CBDCs in the popular press with articles aimed at retail users. And while areas of problems like privacy, accounts for consumers and offline functions clearly exist, the expectations are that they would be manageable.
World Bank studies CBDC
The World Bank analysis of CBDC has been widely reported with particular concern. The Bank has a discussion of CBDC buried in this recent report. It has a discussion of CBDC buried in this recent report. The report is analytical and balanced. It discusses the reasons for a country to adopt a CBDC, as more than one hundred have done or are planning to do. The motivations, as the following section from the report notes, varies widely by country.
“What are potential motivations for introducing CBDC? The relative weight and importance of CBDC depend on specific country contexts and the design features. On one end of the spectrum, countries may wish to preserve the role of public money and safeguard financial stability and monetary sovereignty. On the other end of the spectrum, some countries may wish to use CBDC to supplement traditional digital payments and to promote financial inclusion, government payment disbursements and collections, cross-border payments, competition, and interoperability.” [1]
The report goes on to note the risks and rewards of using CBDC. There it notes that “depending on the design” problems may emerge. It is not an alarming review.
“What are potential risks/challenges associated with introducing CBDC? The introduction of CBDC could disrupt the existing financial-intermediation structure. In addition, depending on design and country context, CBDC could pose risks to financial stability, financial integrity, data protection and privacy, and cyber resilience. Further, it can have implications for the legal and regulatory framework, increased responsibilities of the central bank, and could also lead potentially to currency substitution, especially in the context of cross-border CBDC.” [2]
What should the Fed do?
The benefits of the blockchain model create potential efficiencies in monetary policy. The widespread movement of governments to investigate CBDCs alone suggests the benefits of blockchain or blockchain mimicking technologies applied to monetary functions. For the US, the efforts to develop a digital yuan and a digital euro are the most significant efforts that should command US attention.
However much as the Fed says that CBDC is not a race, the rest of the world sees it as one. The US has a history of underestimating China, particularly. The Fed should move aggressively, in conjunction with other countries, to provide a digital monetary model which can be the basis of an international digital network.
Investor Implications
1. Regulatory efforts in stablecoin will accelerate.
2. International challenges to the dollar’s reserve currency status will motivate more CBDC development in the US. The large banks may develop a niche.
[1] “World Bank. 2022. Reshaping Norms : A New Way Forward. South Asia Economic Focus, Spring 2022. Washington, DC: World Bank. © World Bank. https://openknowledge.worldbank.org/handle/10986/37121 License: CC BY 3.0 IGO.”
[2] Ibid.
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