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CBDCs: bitcoin inspired money for a cashless world

Central Bank Digital Currencies, or CBDCs, have always been a reaction.

The slow decline of populations using cash in the form of coins and paper or polymer banknotes has been greatly accelerated by the coronavirus pandemic.

But the initial reaction was sparked not by a slow and general move to a cashless society, but was ignited by cryptocurrency.

Without Bitcoin there would be no CBDCs. Not in our lifetime, anyway.

The vast success of cryptocurrencies has forced central banks to think harder about the future of money. And certainly, to move faster to reinvent themselves.

Sweden is the example most often cited as the leader of a trend away from cash. By 2016, only 2% of transactions in the Nordic country were made in cash, and only half of bank branches used it.

The Riksbank is engaged in a two-year pilot programme with Accenture to develop an ‘e-krona’ CBDC. This is due to end in February 2021.

Users will be able to make payments instantly with cards, mobile phones or wearables like smart watches, to hold e-krona in a digital wallet and make payments, deposits and withdrawals using only a mobile app.

On a technical level it is underpinned by R3’s Corda blockchain, but as the bank explains, it “differs on a number of crucial points from cryptocurrencies”. The e-krona network will be a private, permissioned blockchain, with only the Riksbank able to add and remove participants.

The central bank will include APIs for interfacing with existing systems, like the interbank payment system RIX and it says it will enforce its own regulatory framework, bound by rules like who has the right to distribute e-krona, who can legitimately sign transactions or store e-krona, and how it will use the R3 architecture to verify blocks of transactions in the bank’s ledger.

new money

While there have been alternative stores of value, from counterfeit coins to Disney dollars, they could never challenge the prominence of fiat currency.

But in 2009 something new came along, based on pure mathematics and cryptography in ever-increasing difficulty that forever upended the way the world thought about money.

In creating an entirely new asset class overnight, its still-unknown creator Satoshi Nakamoto mapped out an alternative future in which central banks faced losing their grip on their lifeblood — their ability to control economies.

So by January 2020, 80% of the world’s central banks, from Canada to Britain and China to Brazil are working on their own form of digital currency, according to the Bank for International Settlements.

The prize for those that can implement it is vast: traceable money, an end to tax evasion, no more criminal gangs using cash to hide their profits from illicit activity.

No wonder the excitement is real among normally reserved economists about the potential good that could come from CBDCs.

For some nations, CBDCs represent a way to break free from the dominance of the almighty dollar. Ending that reliance on the United States government and the dollar as a global reserve currency brings with it significant benefits. No more having to kowtow to the US State Department. True independence. Money a country can reliably use anywhere, no matter how remote a location or fledgling an economy.

the first sovereign

A collection of atolls and islands in the Pacific Ocean seems an odd place for the first serious research into a Central Bank Digital Currency.

But it was the 55,000-population Marshall Islands that was one of the first to consider this new technology. It is quite the feat for a nation with only two hospitals and a GDP about the size of the revenue of a medium-sized company, at $221m a year.

For the Marshall Islands, the indignity of having to rely on the US dollar for most daily transactions is a special kind of horror. Why?

Its remote location in the Pacific Ocean made it the perfect offshore target for the American military to try out its new nuclear weapons. From 1946 to 1958 Bikini Atoll was the location for the most infamous of these experiments. Residents of the coral reef, 6km square, consisting of 23 small but inhabited islands around a central lagoon, were unceremoniously moved out of their homes for one bombing test in March 1954.

Of course, they were promised they and their families would be able to return as soon as the thermonuclear devices had been safely detonated. But scientists miscalculated the yield of the weapon and it produced an explosion 1,000 times more powerful than Fat Man and Little Boy, the bombs dropped on Nagasaki and Hiroshima in World War II.

These tests poisoned the soil and water, killed plant and animal life and rendered the islands unliveable for decades. It rendered the Marshall Islands almost entirely dependent on the US for aid and economic support.

So with that little history in mind, it becomes more obvious why the Marshall Islands might want to disconnect itself from the US dollar. Economists had been talking about a CBDC since 2016, but the country’s Parliament — comprising 33 politicians — passed a law in May 2018 instituting this new legal tender, called ‘Sovereign’.

Sovereign would be capped at 24 million units — aping the deflationary model baked into the architecture of Bitcoin — as a means of controlling inflation.

Subsequent technical documentation showed that the CDBC would be built with the open source blockchain Algorand, a permissionless proof-of-stake protocol and algorithmically set to grow at 4% each year.

The banking community looked poorly on this effort by the small nation to control its own money supply. The IMF repeatedly warned the Marshallese government not to move ahead with the project. This came for one main reason.

If inter-governmental economists cannot put pressure on a country to change its behaviour through diplomatic means, the next stage is to constrain its currency through leveraging interest rates or more forcefully through sanctions, denying its industry the ability to grow. If it does not have to rely on the US dollar to function, the Marshall Islands confers upon itself an incredible new source of power to be independent.

the China factor

At the other end of the economic scale is China. The People’s Bank of China is best-placed to win the race to introduce a CBDC, devoting huge resources since 2014 to a Digital Currency Research Institute.

While it does not have an official name, it is known internally as ‘DC/EP’: digital currency/electronic payment.

“It is a controllable and anonymous payment instrument system of the digital renminbi,” one bank official explained to China Daily, the newspaper run by the ruling Communist Party.

The PBOC will not rely on an outside blockchain, unlike Sweden and the Marshall Islands, and are creating their own system, having applied for a large amount of blockchain patents.

A smartphone CBDC wallet purporting to be from the Agricultural Bank of China leaked online earlier this year, revealing certain aspects of the DC/EP, in that it includes the ability to make retail payments by scanning a barcode, send money or request payments, and touch smartphones together to make p2p payments.

Few outside the bank itself have seen the exact workings of the CBDC, but if press releases from the closely-controlled state can be believed, this new form of money has been tested in four cities already — Shenzhen, Suzhou, Chengdu and Xiong’an — and could be due for release by the time of the Winter Olympics in 2022.

The race is on, and it could be won sooner than we think.