Last week the Reserve Bank of Australia announced a year-long research project with the Digital Finance Cooperative Research Center to explore “use cases” for a central bank digital currency (CBDC). Here is what’s going on.
What is a CBDC and how is it different from cryptocurrency?
Banknotes are a physical form of money we exchange for goods and services. And we’re increasingly making digital transactions, whether tapping credit cards or smartphones. ATM use is down about a third in three years, the RBA says.
Now, the RBA and counterparts around the world are studying new digital forms of money that central banks themselves might issue. Research will examine uses of CBDC for commercial banks – the wholesale market – and a retail version the public may one day use.
Cryptocurrencies, by contrast, are decentralized, unlike “fiat currencies” produced and regulated by governments. Bitcoin and ethereum are among prominent digital currencies relying on cryptography to secure transactions.
To curb price volatility of cryptos, stablecoins have been created to mimic “fiat currencies” by anchoring value to assets such as the US dollar. The failure of TerraUSD and other stablecoins reflects the sector’s infancy. CBDCs might fill the gap.
“A fully realized central bank digital currency has the promise to bring the regulatory certainty and power of digital assets to a place that’s coupled with the trust and faith that we have in money that’s issued by the Reserve Bank today,” said Michael Bacina, a partner at Piper Alderman and a fintech specialist.
Why is the RBA getting involved?
Partly exploratory. “I don’t think it’s inevitable” that the bank will issue CBDCs, says the RBA deputy governor, Michele Bullock.
“In terms of day-to-day payments that touch you and [me] and our friends and family, it’s not clear to us what the case for it is,” she says. “We have banknotes. We have lots and lots of digital money alternatives [including] fast payment now.
“I think we just need to keep our toes in it, and not be at the bleeding forefront.”
The focus will be less on the technology itself but rather settling on design principles of how decentralized such currencies might be, while maintaining standards of protecting privacy that the public can accept.
“Do you put limits on the amount of money people can have in this? Does the central bank issue it directly, or [as] we do with banknotes issue CBDCs via existing banks,” Bullock says. “I don’t think anyone’s come to a complete consensus.”
Is there an appetite?
If an Australian Securities and Investments Commission report on investor behavior released on Thursday is any guide, the market for digital currencies is growing rapidly.
Its survey of 1,053 investors found that cryptocurrencies were second only to Australian shares in terms of most common asset held, at 73% and 44%.
In terms of the value of the holdings, cryptos were also on a par with residential investment properties.
An ASIC survey of 1053 retail investors found their holdings of cryptocurrencies were on a par with resident housing investments, with only their holdings of Australian shares larger. pic.twitter.com/uF7e4iJtgk
— Peter Hannam (@p_hannam) August 11, 2022
What do researchers say?
Andreas Furche, the chief executive of the Digital Finance Cooperative Research Centre, notes the RBA’s ongoing caution.
“It’s not something that’s a done deal,” Furche says. “It’s not clear yet whether from the RBA perspective this is going to fit or be useful or not.”
The trial will be “ring-fenced” with only registered parties taking part. It will, though, be open in another sense: “We don’t have a preconceived outcome.
“Those of us who build or discuss or provide infrastructure aren’t necessarily the innovators that build new kinds of market infrastructure, business models or whatever on that infrastructure,” Furche says. “If we just make that assessment based on what we can think of ourselves, we’re not going to get anywhere.”
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He says the rise of stablecoins indicates there’s an opportunity to meet people’s interest in digital currencies without the exposure to as much volatility.
“Despite the name, [stablecoins] are often still fraught with risk because they’re not necessarily backed 100%,” he says. CBDCs, based on a national currency, are an “ultimate stablecoin”.
What do market participants say?
Chloe White, an independent consultant and formerly Treasury’s representative on the Council of Financial Regulators examining cryptos, says blockchain and the ecosystems that are building around it will continue to function and grow whether governments issue CBDCs or not.
“What we see happening in cryptocurrency markets at the moment very much mirrors what we see in the traditional system,” White says. “You have a so-called real economy where people are transacting goods … and then you have a financial layer wrapped around” with derivatives, insurance and so on.
There may even be national security reasons for having CBDCs and not missing out on emerging technologies and new ways of doing business.
“China, in particular, seems quite determined to want to leverage this technology in some way,” she says. “And there’s barely a corner of the world that you can point at that has influence and economic power that’s not looking at these issues in some way.”
Bacina says the fintech world is evolving faster than the internet at its genesis. “It’s the same as we could not predict Netflix and we could not predict Amazon’s next-day delivery when the internet was being invented and rolled out.
“There are no wires to be put down, and that physical infrastructure to be connected – it’s already there.
“We’re talking about the ability to automate things like bank guarantees, and other slow, manual processes which currently drive up compliance costs.”
As for who might benefit from the RBA and Digital Finance Cooperative Research Center study, Bacina says participants may learn as much as the institutions.
“It’s a six- or seven-way street,” he says. Interest will focus on “deep analysis of systems contracts, regulatory interfaces – that kind of analysis doesn’t occur very often”.