Bitcoin is not going to change the financial world as we know it. You already changed it. The best proof of this is the Central Bank Digital Currencies (CBDC), proposed with implications that would reconfigure the traditional financial system, and that would not have been considered if Bitcoin had not changed the rules of the game.
Bitcoin brought to the world the possibility of transferring digital value globally without the need for intermediaries, without asking for permits, without censorship, among other characteristics.
Many have wanted to replicate this seminal idea with one or another variation. The world’s central banks, some to a greater extent than others, underestimated these experiments, making them less difficult and less cumbersome, but without an internationally coordinated attack that evidenced their concern. Until Facebook announced Libra.
Admittedly, CBDC investigations have been going since at least 2014, when the scenario was raised by the Bank of England. Since then, several countries and organizations have investigated this possibility, created prototypes and carried out pilot tests.
But it was not until it became feasible for Facebook’s 2.60 billion monthly users to access a currency independent of any national jurisdiction that the Central Banks became aware of the inevitability of the ongoing change and the need to intervene and rekindle the debate on CBDCs.
This is what the Director of Regulation of BBVA, Santiago Fernández de Lis, thinks. The practical implications of implementing CBDC are profound, not only for users but for the entire financial structure.
As the Central Banks are institutions whose main responsibility is to ensure economic stability, they cannot take the liberty of making drastic and careless decisions. Agustín Carstens, General Manager of the Bank for International Settlements (BIS), has been of this opinion when thinking about the future of money and payments.
Calibrating the costs and benefits of adopting a CBDC-based model involves projecting scenarios and potential consequences for the financial system as a whole.
All in all, the delays of some represent advantages for others, considering that the cross-border nature of these currencies could modify the current panorama regarding international reserve currencies and foreign trade, even more so at this critical moment for the global economy. With China spearheading the development of CBDC, it is important to review again what Central Bank Digital Currencies are and what their potential implications are.
Central Banks And Financial Intermediation
For many years now, money has been digital. Debit and credit cards have been means of payment that have transferred money to bits in the computer. Digital is not the transcendental component of CBDCs (although it is essential), but the Central Bank.
The Central Bank, as a public institution and monetary authority, has the main functions of preserving the value of the national currency, maintaining price stability and the financial system as a whole. Its main tool for managing monetary policy is the interest rate.
They are in charge of guarding and managing gold and currency reserves; to issue the legal tender money; they serve as treasurers and financial agents of the Public Debt; they are auditors and lenders of private banks; among others.
The Central Bank is the bank of private banks. Simplifying the complex financial system of a country, it can be seen that it is constituted on two levels, where central banks act as intermediaries between individuals and the Central Bank.
The Central Banks exercise their monetary policy through the private ones, raising or lowering interest rates, using them as a vehicle to increase liquidity and currency. It is also the Central Banks that mediate in the interbank transfers of individuals.
The Central Bank is also the bank for other financial intermediaries and private credit institutions. The only really public money issued by the Central Bank is cash.
Other means of payment represent private money, that is, responsibilities and votes of confidence contracted with commercial banks, telephone companies, FinTech companies, and others, which in the end will have to render accounts, not only to their users, but to the Central Bank.
All in all, from the traditional financial system there has been a growing interest in eliminating cash. Perhaps the main argument for this has been to combat the criminal use of cash that facilitates its anonymity and fungibility, both to avoid taxes and money laundering, and to finance illegal activities.
There is also the high cost of producing new units, even more so in hyperinflationary or devaluation scenarios and frequent changes in monetary cones.
Cash also limits the scope of monetary policies based on negative interest rates, as it provides a zero-rate alternative in its storage. Lately, following the declaration of a pandemic by COVID-19, the potential of cash as a disease propagator has been added to the arguments.
The only partially direct relationship between individuals, be it a company or an individual, and Central Banks, is cash, so eliminating it would further expand the need and dependence on financial intermediaries.
In addition, the cash has advantageous properties that would mean a loss to sacrifice, especially its availability outside the network, its ease of use that does not require education costs, its immediate liquidation, among others.
All in all, with the introduction of CBDCs, the picture changes.
What Are The Central Bank Digital Currencies?
Central Bank Digital Currencies (CBDC) would be a more flexible and programmable form of Central Bank money that, depending on how it is designed, could both maintain the anonymity of cash and eliminate the need for financial intermediaries, as well as increase supervision and surveillance. monetary policy of individuals, maintaining the presence of private banks.
Also, it could imply a digital cash subject to interest rates, a greater monopoly of the Central Bank of financial activity and more scope for its monetary policies.
The current literature and research on the subject contemplate the use of distributed databases such as those used in blockchain networks such as Bitcoin for the technical architecture of CBDCs.
The main difference from Bitcoin would be that decentralization would not be desirable; rather, network security and transaction verification would be the sole responsibility of the Central Bank and, in any case, of trusted institutions of the bank. However, there is research that proposes another type of database, so the use of blockchain is not a limitation to create CBDC.
Central Bank Digital Currencies Attributes
Depending on the objective that is intended to be achieved with the CBDC, its potential attributes vary. For example, regarding its scope, it could be universal / retail, in the event that its use is open to anyone; or restricted / wholesale, when its use is limited to financial intermediaries.
In the universal case, the CBDC could allow any person or business to make electronic payments using money issued by central banks using the means of payment provided by the institution, as well as deposit their money directly into their accounts. The central bank would then become the custodian and service provider of legal tender digital money.
In the restricted case, the reality would not be far from the current reality for individuals in their daily lives, although they could benefit from improvements in the efficiency of banking institutions.
As for the approximation given to financial information, that is, if it is inclined to maintain the anonymity of the cash or if, on the contrary, it seeks to link money to identity, the CBDC would use a token system, to the first case, and an account system, for the second. Most likely, the general orientation tends to the account system, not only because it increases supervision and control, but because it has been tested for more years than that based on tokens.
Finally, the CBDC may or may not accrue interest. Introducing an interest rate in this form of digital cash would broaden the scope of Central Banks’ monetary policy. For example, it can serve for anti-deflationary policies by encouraging consumption and discouraging savings. All in all, this would face criticism of excess in the meddling of the economic authority in the behavior of the monetary agents, as well as the introduction of a tacit form of tax.
Possible CBDC scenarios
To weigh the implications of CBDCs in the traditional financial system, BBVA researchers have proposed four possible scenarios in which the aforementioned attributes are ordered and reordered, ranging from the least disruptive scenario and consistent with the stabilizing responsibility of the Central Bank, to the most disruptive horizon.
The first option would be a scheme in which the use of CBDCs is restricted to financial intermediaries, whose accounts would be linked to identities but would not earn interest. This scenario would increase the efficiency of the wholesale payment system; it does not alter the lives of individuals or the making of monetary policies; and it could increase competition for banks with non-bank payment institutions.
The second option opens the CBDC to the general public, maintains cash anonymity by relying on a token system, and therefore no interest would be charged. Efficiency gains exceed those of the first option by eliminating financial intermediaries from money transfers. Its role would be reduced to other financial services such as credits and loans, although its capacity would be weakened.
The third option introduces the possibility of CBDC with interest rates, that is, using tokens open to the public. This option is focused on increasing the scope of monetary policies. It involves the total elimination of cash, which has high costs in educational processes and device distribution.
The fourth option proposes a universal CBDC linked to identifiable accounts. It would be like having a central bank account. This would increase the supervisory powers of the monetary authority over individuals.
It could be the case that a private banking system with a limited scope emerges that competes with the central bank, but that would be at risk that, in periods of instability, individuals turn to the Central Bank and banks fall short of CBDC.
Due to the conservative tendency of central banks, the first option is most likely to be the first to be implemented in the short term because, although the benefits are low, so are the costs.
The IMF has also proposed the idea of a synthetic CBDC, issued by Central Banks, but managed by financial intermediaries, who would be required to cover 100% of reserves at the central bank, unlike the current fractional reserve.
This raises questions such as who knows who are the holders of CBDCs, the central bank or only private intermediaries? Are there going to be differences between the role of banks versus financial technology companies or big technology companies, including access to accounts at the central bank?
Central Bank Digital Currencies (CBDC) present many challenges, as we have seen, so their implementation has been quite limited, although it has been extensively investigated.
Studies carried out by the BIS have shown 80% of banks interested in researching and studying CBDCs, while only 50% have dedicated efforts to Proof of Concept and Experimentation, and only 10% have sought to develop pilots, taking Sweden and China as main exponents.
When central banks were asked if they planned to launch a CBDC in the medium term, be it retail or wholesale, after having studied the option, few think that the design of their own CBDC is likely.
The likelihood of creating a CBDC depends greatly on the different objectives of both central banks and the authorities of the specific country. Since the authorities of the countries do not share the same objectives, there will always be those who advance before others.
However, the possibility of cross-border competition from different CBDCs is one of the main concerns in falling behind in this technological race, as it could compromise dominant positions in the global market. However, whether or not to trade internationally with a CBDC will depend greatly on the characteristics of the coin.
In the event that CBDCs are designed to emulate cash, while maintaining anonymity, it will not be possible to limit its use to the residents of a country, which would raise competencies for global seigniorage.
Currently, this is limited by the portability of physical money, but by going digital, these logistical difficulties would disappear. This could lead to an increase in the demand for foreign currencies, especially in countries with monetary instability.
Another conclusion that can be drawn from this study is that the obsolescence of traditional financial intermediaries depends on a practical decision of the Central Banks.
Being true to their principles of stability, they are unlikely to take such disruptive actions. But it is not surprising that even outside the scope of Bitcoin, and precisely thanks to the technology that was put on the table, in the traditional financial field, financial intermediaries became expendable. Their existence is only intended to keep the current status quo unchanged, but they are no longer necessary.
Of course, its removal has many other consequences. It not only supposes an increase in the costs and responsibilities of the Central Banks, which would have to assume all the functions of financial service providers. This could degrade the service by being concentrated in a single entity without external powers, which means increasing the monopoly of the central bank, not only in the creation of money, but also in its administration.
But above all, one of the biggest risks of this monopoly is in individual privacy. The Central Bank, with risks of being politically biased as it has happened different times throughout history, but more recently in Venezuela, would maintain full surveillance and control over transactions, so that its censorship capacity would be higher than it is today.
It would be they who would decide which purses to admit or veto, which would affect the right to dissent, and may partially favor some political faction.
Also, the establishment of a single point of failure increases the risk of hacking into the system, remembering that all software and all hardware, no matter how secure it is, is always susceptible to attacks. And without attacking, there are the configuration errors and glitches that the system may have, putting the reputation of the Central Bank at risk.
It can be seen that the CBDC debate is not so much about convenience and digitization as it is about a fundamental change in the financial system, at least in terms of money and payments. So far, experiments have shown no substantial improvement over existing systems.
There is also no special demand for these coins from society, and there are huge operational costs. Although there is no urgency at present to implement this type of system, the truth is that the Central Banks of the world are preparing for such a scenario.
Bitcoin Gold And Bones Are Still Better
No matter what the central banks are placing on the gaming table. Bitcon, gold and government bonds continue to be the most striking assets for most investors when it comes to capital protection.
That statement can be found in the recent article written by BitMEX Research, where it says that the central entities or component banks no longer view “volatility-related bets” — as recommended by the same team back in 2019 — as the most effective way to protect an investment portfolio against financial market risks and inflation and it was written in cryptonews.
The recommended ‘volatility related bets’ in 2019 mainly consisted of call options on the VIX, a measure of volatility commonly used in the stock market, as well as put options on listed mutual funds (ETFs) backed by corporate bonds.
The idea then was that in the event of a financial crisis, the volatility of the stock market would likely increase, leading to a massive payment of the VIX call option, and the corporate bonds would decrease, resulting in a massive payment in the ETF put options.
However, following the COVID-19 crash in the financial market, the BitMEX Research team has concluded that both VIX call options and corporate bond ETF put options are “too expensive to offer reasonable protection”.
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