How central banks should treat virtual currencies, particularly stablecoins, has been hinted at by the Bank for International Settlements (BIS) together with a group of central banks in the latest CBDC report titled ‘Central bank digital currencies: financial stability implications report‘. The report was released 30 September 2021 by the BIS.
Referred to in the report as “privately issued digital money” or sometimes loosely “other digital money”, virtual-currency treatment by central banks in an era of financial-technology innovations was variously mentioned. Below, I will identify 4 major express or implied standpoints of the BIS with the group of participating banks on “privately issued digital money” or virtual currencies and try to point out the implications. This, I hope, will help stakeholders—particularly virtual asset service providers (VASPs)—see how the BIS and the participating central banks are thinking, and the possible implications of this on future actions.
Virtual currencies are generally considered risks to financial stability.
Generally, virtual currencies are seen more in the report from the angle of their risk implications to financial stability. In pointing out why it is important for central banks to consider the risks of CBDC adoption against its potential benefits, “certain new forms of private sector money” was referred to in the report as an example of one of the risks that central banks should consider. Below are two major specific risks that have been identified in the report as being associated with “new forms of private sector money” or virtual currencies:
First, from a regulatory-risk angle, the adoption of “other digital forms of money” (as well as CBDC) is seen as a development that may lead to smaller bank deposits. This portends a liquidity risk in the banking system. And relying on any alternative funding—whether through central bank funding and monetary subsidy or other options—may also come with its own regulatory risks, observes the report.
Indeed, the introduction of new forms of private money (as well as CBDCs) could potentially affect the resilience of banks’ liquidity risk profile. This is because with CBDC and other private forms of money such as virtual currencies, bank deposits would decrease. This would put a strain on a bank’s liquidity. And this can portend a serious risk on the health of the banking system in the event of stress.
Second, in recommending two of the broad categories of safeguards for CBDC take-up and usage, warding off “risks from substitution with private money” is referred to. In the report, quantity-based safeguards and price-based safeguards, or a combination of both were suggested as risk-management mechanisms. Whether by limiting the volume of transactions per day or the volume of money that can be stored or received in a CBDC wallet, these restrictions are seen as safety measures that “private money” such as bitcoin and other virtual currencies cannot accommodate.
The two concerns identified above are understandable. Compared to fiat currencies, the “freedom of money” that virtual currencies provide to users in a distributed and decentralized peer-to-peer network without central-bank control or restrictions is strongly believed by most virtual-currency adopters to offer greater value compared to fiat currencies, whether paper, electronic, or digital.
But are virtual currencies or other forms of private money all about risks without benefits?
Though virtual currencies have their weaknesses and threats—as do fiat currencies—they also have their strengths and offer opportunities. As cryptographically secured and digital forms of medium of exchange, store of value, or unit of exchange, virtual currencies could become options in today’s financial system or help improve trust in a traditional financial system where trust is chipping away.
Virtual currencies, specifically stablecoins, as innovations in a future financial system.
In the same report, it is stated that “a CBDC would likely co-exist with private forms of money in a future financial system that could look very different from that which we observe today.”
I would like to think—as I imagine many stakeholders would as well—that the future financial system referred to above is already here. But the way this future is seen in the report, it appears to be limited to stablecoins, not other types of virtual currencies such as bitcoin, ethereum, and the thousands of others out there today.
According to the report, since stablecoins have only started being developed, issuers must “satisfy regulators that they are safe” before they can be adopted in the financial system. This clearly hints at stablecoin regulation by central banks eventually. In the US, the possible regulation of stablecoins in the financial system is currently a topical issue. Given the global implications, I also expect other jurisdictions to start paying some regulatory attention to stablecoins. Commonly pegged to fiats, assets, contracts, and sometimes simply powered by algorithms, stablecoins are presently the bride of fiat-crypto, crypto-fiat transactions.
Virtual currencies or “other forms of money” are considered fragmented, therefore not interoperable enough for global adoption.
Interestingly, I observe from the report that while central banks exploring CBDC adoption are said to be “bound by principles to design products that would co-exist and interoperate with other forms of money“, stablecoin issuers are not.
Understandably, the idea of achieving interoperability here is to ensure that the design and issuance of CBDCs by various central banks around the world do not result in the fragmentation of the payment ecosystem. In fact, “other forms of money”—including virtual currencies I believe—are considered too fragmented to offer the level of interoperability that is expected in a global payment ecosystem. The BIS and the group of participating banks in the report believe that CBDCs offer a better and safer option.
Now, I also understand from the report that the BIS and the group of participating banks in the report are expressly accommodating of stablecoins. But apart from CBDCs, they are silent on other types of virtual currencies or “other forms of money”. And the silence is loud. This is why I doubt that bitcoin, Ethereum, Litecoin, and other cryptocurrencies will have a place in the “future financial system” that is imagined in the report.
In the interim, virtual currencies (referred to as “private money and tokens”) are expected to keep operating pending each central bank’s regulatory readiness.
According to the report, “providers of private money and tokens are expected to continuing [sic] developing and expanding their service offerings” in the interim. It is during this indefinite interim period that the jurisdictions represented in the group of participating banks are expected to independently decide whether to issue a CBDC or actually issue them. As stated in the report, the “actual introduction of CBDC could be some years away”.
Although not expressly stated in the CBDC report, it is expected that jurisdictions that have already designed and issued their CBDCs will determine how they wish to treat “private money and tokens”. Well, in Asia, the People’s Bank of China has undoubtedly made it clear that having introduced its own Digital Yuan it will not be friendly—euphemistically speaking—to virtual currencies. In Northern America, the US Reserve Bank after years of looking back at the US dollar and seeing China running ahead, appears to now be looking at its own digital dollar. And in West Africa, Nigeria cannot just wait to hit its crypto-loving country with the Central Bank of Nigeria’s (CBN) own eNaira—not until ‘Project Giant’, as the CBDC project is called, eventually slipped on its own banana peel having missed its own launch date.
From a virtual-currency perspective, however the road the central bank of each sovereign country decides to take to the future financial system, I think that central banks should stop shying away from introducing effective regulatory frameworks for virtual currencies.
Rather than considering virtual currencies or private digital forms of money as only constituting risks to the financial system, virtual currencies should be seen as financial-technology innovations calling for regulation in a financial system whose future is already here. As with most innovations, there would be strengths and weaknesses; and there would be opportunities and threats. So focusing on or seemingly focusing on the threats and weaknesses alone betrays the single story. And many innovators—largely frustrated in the current state of lack of clarity, uncertainty, and growing hostility—find such a one-sided, single-story approach a curious one. Regulators are expected to harness the resources at their disposal for adaptive, innovative, and intelligent regulation and supervision that innovations in the 3rd-generation internet require. Central banks are more than capable of providing efficient and effective regulation—a thing that can only be achieved through inclusion. Exclusion can only help central banks—and regulators generally—achieve the opposite result: loss of control.
This is why as also suggested in the report, central banks should be confident that as innovations evolve effective monitoring and regulation can be introduced. Failing to regulate virtual currencies or introducing blanket restrictions—as the CBN decided to do early this year for example—will not necessarily help to address the financial-stability implications that central banks are genuinely concerned about. Denying an entire emerging industry access to the banking and financial system is not the answer. Far from it. In fact, such restrictions will most likely end up harming the future financial system that the financial-service industry should be accumulating capabilities for in a global, tech-driven economy. It is through an accessible, nondiscriminatory, open, and transparent system that a truly sound financial system is built. It is this that builds trust in the financial system. And trust is the strongest currency of the financial system, not force.