“Blockchain Innovation: Why Central Bank Digital Currencies (CBDC’s) Will Not Eliminate the Need for Cryptocurrencies”
The invention of cryptocurrency has developed the opportunities for investing and transacting in online peer to peer markets, where Bitcoin, Ethereum and other altcoins have offered a novel non-sovereign alternative to fiat money. Cryptocurrency is not governed by a traditional central authority, and subsequently not legally enforced by the UK, US or EU governments as a currency, or legal tender. However, as of February 2021, there were 4,501 crypto coins circulating globally in the crypto-economy. In response to the explosion of blockchain development, many central banks, including the UK and China, are contemplating their options to bring financial innovation to existing sovereign economic systems.
Innovation is one of the most influential factors which have emanated from cryptocurrencies, forcing central banks to face an adaptive, fast paced global financial market with blockchain adoption. As cash declines and digital payments rise in society, it is inevitable that payment infrastructures need to accommodate global commerce transactions, at a low cost and fast speed, therefore requiring interoperability. In the UK case for example, The Bank of England are considering the introduction of a Central Bank Digital Currency (CBDC). This would give the central bank the ability to build on their traditional centralised role in the economy, ensuring stability by providing certainty and liquidity in the financial system, as the UK’s monetary and fiscal policy manager, against a tide of ‘private’ digital money production.
Since the Bank of England’s charter by Parliament in 1694, monetary policy in the United Kingdom has typified the way in which the political and economic activity of fiat currency creation has been undertaken and legally enforced. Key decisions on how much currency, and what types of currency are in circulation, are predominant examples of the ways in which powers are exerted through monetary policy by this central authority. Yet, cryptocurrencies including Bitcoin, are not circulated for public use by the UK’s central bank. Bitcoins for example, are only able to be issued once mined on the Bitcoin network and acts as a decentralised and distributed cryptocurrency.
Due to this decentralised nature and absence of legal standing of cryptocurrencies as UK, US or EU legal tender, opponents of crypto argue against supporting the use of it as a medium of exchange, or investment instrument within the UK’s free market. However, the regulatory landscape is changing with many governments such as the US and the EU including the UK, taking a firmer approach to regulating cryptocurrencies — through instruments such as the UK’s crypto-asset regulatory framework. This raises socio-economic debates on the need for the production and circulation of both state money and private decentralised money in sovereign state economies, where FinTech is harnessed and encouraged in line with democratic free market principles.
In a new article entitled “Will Central Bank Digital Currencies (CBDC’s) Eliminate the Need for Cryptocurrencies?”, I argue that, if cryptocurrency (in the form of crypto assets) become progressively governed by regulation through incorporation into existing and developing legal frameworks, far from being exclusive assets, both a CBDC and crypto-assets present a range of potential opportunities to contribute to a host of financial instruments, that can operate in an interoperable and inclusive FinTech sector. This I suggest, will result in supporting an open, competitive, and free market, ultimately benefitting end users in an increasingly globalised financial system.
In such a system, there are both advantages and opportunities, as well as disadvantages and challenges for both CBDC’s and cryptocurrencies. The introduction of a CBDC has the potential to promote financial inclusion for those who are currently unbanked or underbanked. In this regard, a retail CBDC would work well for end-users who require low cost, fast transactions, and easy accessibility. Interoperability with current payment infrastructure will be a necessary requisite for retail, or wholesale CBDC, as an intervention tool for financial inclusion.
One of the facilitators for success of a digital currency project that acts as an intervention tool for financial inclusion (whether it be the case of state or private money), may be the authority of the issuer and the role they have with the general public and society as a whole. For example, a central bank such as the Bank of England who has had a long history of being the sovereign issuer of state currency, not only have the explicit rights and privileges to ‘print’ or ‘create’ money but also the implicit trust and accountability of a state entity. Therefore, the historical role that the Bank of England has taken as the state-authorised central bank, in light of the contemporary rights and privileges which have dictated their historical operational monetary and fiscal policy activities, should be considered as a key facilitator in a potential CBDC’s success.
One specific benefit of a CBDC over cryptocurrencies thus is the reputation of their creator. The Bank of England as the UK’s central bank historically, has taken the role in directing monetary policy and maintaining financial stability, for the public good. This implicit trust by the public is grounded in knowing that the Bank of England as an accountable public institution will not suddenly fail, liquidate, or disappear with their money, as was the case for example with the cryptocurrency ‘Onecoin’.
Yet, for all the failed cryptocurrencies and illegitimate projects that make the headlines, it would be unwise to suggest all cryptocurrency projects are doomed to fail, while Bitcoin and Ethereum (among many others) strive for more market capital, legitimacy, and nation state legalisation. The competencies of crypto coins including stable coins should not be overlooked or understated here. Low transaction costs, a low level of entry, worldwide speed, and pseudo-anonymity of the transactions, are often posited as the main advantages of cryptocurrency use, making it an attractive transaction media, particularly for example in Africa and developing countries.
Bitcoin has been reportedly used as an alternative currency option, particularly in South American countries to avoid rising hyperinflation. Venezuela’s success in driving crypto adoption as number 3 in the global crypto adoption index for example, illustrates a logical response to how citizens use cryptocurrency to mitigate economic instability and government mistrust. There are drawbacks to cryptocurrency use including for example Bitcoin’s high transactions fees for low-cost goods services when used as a medium of exchange. However, there are a number of cryptocurrencies on the market that have lower transaction fees than Bitcoin, including Dash, Ethereum, Litecoin, Bitcoin Cash and Ripple; whilst some such as Nano claim to offer fee-less transactions. Open competition from a plethora of cryptocurrencies provides options for an alternative currency, with user friendly payment systems and the stability this provides as an applied medium of exchange for consumption in the real economy.
Volatility is also an issue which has led to price fluctuations putting it at odds with the requirement for currency to remain a stable unit of account and good store of value. Price volatility around Bitcoin and other top market capital cryptocurrencies, therefore, illustrates the necessity for stable coins. Bolstered by the Decentralised Finance (DeFi) markets, stable coins can provide lower volatility crypto-assets which can be pegged to fiat currency. The adoption of stable coins as stable crypto assets is particularly useful for emerging blockchain applications, such as DeFi. These can act to welcome retail and institutional investors into the market who are seeking cash flow and income generation through crypto yields. Particularly in the DeFi space, staking and yield farming using decentralized platforms such as Compound, BlockFi, or alternative platforms, or taking advantage of decentralized lending and borrowing of crypto collateralized stable coins, can provide potential passive income, and help to stabilize volatility in the crypto markets.
Potential CBDC’s and crypto-assets, therefore present a range of opportunities and challenges to contribute to an inclusive, globalized financial system. Singularly, neither can exclusively bring the entirety of benefits to users nor individually overcome the obstacles required for guaranteed future stability in their totality. But both CBDC’s and crypto assets are capable of satisfying different properties and the utility of money — a unit of account, store of value, and medium of exchange, to various extents for the public good; a key objective for the Bank of England. Ultimately, the plethora of public and private currencies on the market, once reached legal maturity in terms of governance, I argue can provide the element of choice to consumers in an open, innovative, and competitive market that engenders democratic, free market principles.
Kelly Coulter is a Blockchain, Crypto and Innovation scholar based at UCL School of Management and the University of Essex.
This blog has been adapted from her paper ““Will Central Bank Digital Currencies (CBDC’s) Eliminate the Need for Cryptocurrencies?”, available on SSRN.
