Why central banks are getting into the crypto game

Central banks are getting into the digital currency game. For the crypto sector — and monetary systems more generally — the consequences could be huge


From bitcoin to ethereum, digital currencies have been heralded as a new dawn for money. They allow for faster, cheaper transfers, promote financial inclusion and offer greater privacy, according to their proponents. 

However, the promise of anonymity has also made them a favoured financial medium for fraudsters and criminals. And beset by explosive volatility, they fall far short of being a viable payment method. But what if that wasn’t the case?

For monetary authorities worldwide, this is the trillion-dollar question. Spurred by the crypto sector’s meteoric rise, dozens are looking at launching their own central bank digital currencies (CBDCs) — virtual money that replaces cash with electronic tokens. 

Done correctly, this could democratise finance, clamp down on criminality and offer far greater efficiency. Yet deep in CBDCs’ digital DNA are concerns around state surveillance and individual privacy and the prospect of a cashless society that might not work for all.

Playing catchup

For years, central banks had little more than passing interest in virtual money. When Facebook announced Libra, a proprietary digital currency that would monetise its sprawling social network, that abruptly changed. 

“After Facebook made its announcement in mid-2019, central banks became concerned about monetary sovereignty,” explains Ole Moehr, associate director of the GeoEconomics Center at the Atlantic Council, an international think tank. “They were, and still are, worried that they might lose that sovereignty if a digital currency like Diem [Libra’s new name] could effectively leverage the platform’s 2.8 billion users.”

Two years on, central banks are scrambling to catch up. The Atlantic Council’s GeoEconomics Center, which tracks CBDC development globally, found that 35 monetary authorities were researching virtual currencies in mid-2020, Moehr says. Today that number has more than doubled. 

China, Cambodia, and the Bahamas are leading the pack. Each has a pilot CBDC in circulation and there is speculation of a national rollout in China next year. 

Eager to make up ground, though fundamentally more cautious, Western economies are moving ahead with their own CBDC plans. In April, the Bank of England and the UK Treasury launched a taskforce to examine the potential of a digital pound, snappily dubbed “Britcoin” by Chancellor Rishi Sunak.  

Yet as Facebook’s Diem shows, there remain some fairly hefty regulatory roadblocks. Stablecoins - cryptocurrencies that peg their market value to an outside asset, such as the US dollar or gold - carry systemic risks, G7 central bankers and finance ministries have decided, reiterating at a meeting in early June that tighter regulations be applied before launch permission is granted. 

The same goes for their own CBDCs; digital currencies must operate “within appropriate privacy frameworks and minimise spillovers”, G7 finance ministers concluded this month. 

CBDCs vs cryptocurrencies

This commitment to regulation is the single biggest difference between CBDCs and cryptocurrencies such as bitcoin or ethereum. 

They’re likely to share some of the same foundational technology, namely using blockchain, an electronic ledger that allows transactions to be recorded and accessed in real time. However, cryptocurrencies are decentralised and unregulated, governed not by a single entity but a disparate band of online custodians. By definition, CBDCs are controlled by a central body. 

The arrival of CBDCs could therefore precipitate the demise of their unregulated forebears, some experts believe. 

“In terms of the use case for bitcoin and ethereum as currencies, CBDCs certainly do throw that up into the air,” says Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown. 

“If there’s an alternative system of digital currency that is supported and regulated by central banks, people will migrate over to that system, not least because their money will be guaranteed.”

Ten pounds, dollars, or euros of CBDC would, in other words, always be worth ten pounds, dollars, or euros, backed by the full faith and credit of the government. Cryptocurrencies, on the other hand, are prone to violent swings in value, hampering their ability to serve as a serious payment medium. 

Then again, this speculative nature is precisely what appeals to so many crypto enthusiasts. Rather than treating their holdings as a viable currency, most view them as assets, hoping for stratospheric returns, or as hedges against inflation, taking the place of gold. That’s unlikely to change, even with central banks in the game. 

Perhaps the more pertinent question is whether CBDCs will squash the growth of global stablecoins, such as Diem. While they could well co-exist in a shared regulated ecosystem, certain rivalries are likely to emerge if non-state virtual currencies offer their customers interest, throwing the gauntlet down to CBDCs, which aren’t expected to carry financial incentives.

Goodbye to the commercial bank — and cash?

A stablecoin versus CBDC showdown would not be a bad thing for consumers - competition drives down costs, after all. But there’s one group who will be watching the development of digital money with trepidation: commercial banks. 

As CBDCs are a complete replacement for physical money, not simply a representation of it as is the case with today’s electronic cash, the intermediary role of high street or online banks would, in theory, be very limited. With money held directly by the customer (on their phone or other digital device) why involve a potentially costly middleman? 

The answer, says Anthony Culligan, founder and chief engineer at blockchain company SETL, is expertise. 

“There’s still going to have to be somebody who curates us into this digital money world,” he says. “The Bank of England is a small place, it’s not going to be running a service for 50 million customers. It couldn’t do it, because it’s not a technology organisation in the same way commercial banks are.”

The cash economy is likely to be less resilient. The disappearance of physical money is already well advanced - only 23% of transactions in the UK relied on cash in 2019, according to trade body UK Finance, down from close to 60% a decade earlier. Contactless payments have proliferated during the pandemic, a trend that CBDCs, being wholly virtual, will almost certainly accelerate. This could disenfranchise poor, rural and elderly communities that largely rely on cash, particularly if digital currencies are accessible offline. 

It’s possible, however, to make quite the opposite argument: that CBDCs will advance the cause of financial inclusion. For people estranged from the banking system, there’ll be no need for an account or credit card to access their money, just an electronic device. 

Privacy concerns

A shift away from cash could also help authorities crack down on fraud, because with less physical money in circulation, it’ll be harder to launder large sums. Similarly, banks will have an easier time keeping track of currency movement, with the ownership of every electronic token digitally documented, helpful when tackling the likes of tax avoidance. 

This sort of surveillance capability is, on the flipside, fraught with civil liberty concerns, analysts argue. 

“Privacy is a major concern, and is related to trust in both governments and big technology companies,” says Sabrina Rochemont, chair of the Institute and Faculty of Actuaries (IFoA)  Cashless Society Working Party.

“If accounts are held with a payment service provider and the use of a CBDC is free of charge, consumer and transaction data may become the revenue stream for payment businesses. Most of us leave vast trails of data in our daily lives as we seek convenience. Who do you trust more with your data: a central bank or private businesses?”