The case for central bank electronic money and the non-case for central bank cryptocurrencies

Aleksander Berentsen and Fabian Schar of University of Basel have a piece on the hot topic of cryptocurrencies.

They point to this interesting diagram on types of money (Just like the money flower):

They say yes to central bank e-money but not for central bank cryptocurrencies. They say e-money is a straight forward case and is easily doable.

We believe that there is a strong case for central bank money in electronic form, and it would be easy to implement. Central banks would only need to allow households and firms to open accounts with them, which would allow them to make payments with central bank electronic money instead of commercial bank deposits. As explained earlier, the main benefit is that central bank electronic money satisfies the population’s need for virtual money without facing counterparty risk.9 But there are additional benefits.

We believe this because we conjecture that “central bank electronic money for all” would have a disciplining effect on commercial banks.11 To attract deposits, they would need to alter their business model or to increase interest rate payments on deposits to compensate users for the additional risk they assume. The disciplining effect on commercial banks will be reinforced by the fact that, in the event of a loss of confidence, customers’ money can be quickly transferred to central bank electronic money accounts. In order to avoid this, the banks must make their business models more secure by, for example, taking fewer risks or by holding more reserves and capital, or they must offer higher interest rates. This simplicity of moving funds to central bank accounts has the potential to create additional volatility. For example, there could be rapid shifts of large quantities of money from commercial bank deposits to central bank accounts that have no real causes (bank panics that are unrelated to fundamentals). In this case, the central bank is called upon to provide commercial banks with the necessary temporary liquidity by offering standing facilities where commercial banks can obtain central bank money against collateral in a fast and uncomplicated way.

In a way, the authors agree with the ongoing Swiss initiative of Sovereign money .

Recently Denmark had rejected electronic money for the opposite reason that it will lead to instability in banking. This is also like monetary policy coming full circle. How central banks emerged to monopolise the currency function from private banks and now they are being seen as competition to these banks over deposits!

Though, they reject that central banks issue their own cryptocurrency:

The distinguishing characteristic of cryptocurrencies is the decentralized nature of transaction handling, which enables users to remain anonymous and allows for permissionless access. These key characteristics are a red flag for central banks, and we predict that no reputable central bank would issue a decentralized virtual currency where users can remain anonymous. The reputational risk would simply be too high. Rather, central banks could issue central bank electronic money. This money would be tightly controlled by them, and users would be subject to standard KYC (“know your customer”) and AML (“anti-money laundering”) procedures.

Some central banks supposedly are evaluating the issuance of a central bank cryptocurrency. However, a closer look at these projects reveals that these are not cryptocurrencies according to our definition in Figure 1. The projects usually are highly centralized.

In general, we don’t think that a central bank should be in the business to satisfy the demand for anonymous payments. We believe that such a demand can and will be perfectly satisfied by the private sector, in particular through cryptocurrencies. History and current political reality show that, on the one hand, governments can be bad actors and, on the other hand, some citizens can be bad actors. The former justifies an anonymous currency to protect citizens from bad governments, while the later calls for transparency of all payments. The reality is in between, and for that reason we welcome anonymous cryptocurrencies but also disagree with the view that the government should provide one.

Whatever be the outcome of all this e-money and c-money, it is fascinating to go through the same debates when physical currency was issued…


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