Inevitability of cryptocurrency forcing central banks to reform –OMFIF/IBM report

Central banks are finally warming to the idea of digital currency as a direct response to this new currency reality that began to take shape after the 2008 financial crisis.

Collapsed confidence

The collapse of trust in financial institutions, both central banks and private sector institutions, as well as the general decline in the usage of cash in many developed states has been largely responsible for the surge in popularity of digital alternatives.

These key findings are contained in a study survey undertaken by tech giant IBM and OMFIF during the year 2019. The study collected contributions from some 23 ‘leading’ central banks, among others while the research itself zeroed in retail central bank digital currencies (CBDC) as an alternative to wholesale CBDC.

A retail CBDC can be used like a digital extension of cash by all people and companies, whereas a ‘wholesale’ CBDC can only be used by ‘permitted’ institutions as a settlement asset in the interbank market.

The OMFIF/IBM study comes to a conclusion that the cryptoworld has always known, that payments system must and are evolving fast as service providers attempt to satisfy changing consumer needs. Those failing to heed the call innovate or reform will be left behind.

And why cryptocurrencies have emerged

Fiat currency payment systems are notoriously slow and costly, a scenario that has been subsisted for decades with no solution in sight. In the meantime, it is the privately issued cryptocurrencies like bitcoin and ethereum that offer an escape route for those disillusioned with fiat money, a fact observed from the study.

The OMFIF/IBM report acknowledges that private sector institutions, both incumbent and nascent, have so far been able to develop solutions that overcome some existing shortfalls in the fiat payments system.

In fact, the proliferation of apps and devices that support mobile payments—including in emerging markets that lack traditional banking infrastructures—showcases the private sector’s agility and ability to innovate and tailor services to various types of consumer and markets.

It is for this reason that the report cautions central banks as follows:

“Whether or not central banks like the sight of these developments – which generate an inherent threat to their senior position in the financial system and to their monetary sovereignty – they must remain alert to shifts in payments habits……It is in central banks’ best interest that they are neither left behind nor displaced.”

The OMFIF/IBM seems to suggest the so-called leading central banks are now refraining from the usual approach of trying to stop or to kill privately issued cryptocurrencies. Of course, that may not be the case with smaller or non leading central banks, their approach is still one driven by fear and ignorance.

Learning from the success of Bitcoin

For instance, the Central Bank of Tanzania (BoT) recently issued an advisory against the use of cryptocurrencies. BoT tries to justify its decision by giving the same opaque and unintelligible reasons for the advisory, which seemingly are out of step with recommendations of the OMFIF/IBM. It is this kind of mindset that will see Tanzania or those following a similar blueprint being left behind and thus lose out.

Central banks—particularly those from emerging markets—must take a cue from leading peers like the Risibank of Sweden. Management of this institution made a conscious decision to learn from privately issued digital currencies instead of fighting them.

Indeed, the governor of Risibank, Stefan Ingves, was widely quoted in the global media suggesting that the threat from privately issued currencies has been essential in forcing them to see the need to reform. Risibank is one of the few central banks that are leading in effort to create a CBDC.

Meanwhile, (and perhaps ironically) the OMFIF/IBM report states that central banks are now claiming their research into digital currencies is driven in part, on the desire to improve cross border payments and financial inclusion. Part of this report reads:

Central banks raised many reasons for researching digital currencies, including financial inclusion, the potential of CBDCs for cross-border payments, and fostering trust in monetary authorities. Across all central banks in our sample, this latter point was identified as the second-most important reason, being mentioned by 69% of respondents. In the words of one respondent, people with a ‘lack of trust in financial institutions may be brought back into the fold, ‘if the retail CBDC can exhibit advantages in these areas’. 

The elusive solution to financial exclusion

The fact is as much as 1.7 billion of the world’s adult population lack access to financial services and it has been that way for decades. Privately issued cryptocurrencies—which began with the creation of bitcoin right after the 2008 financial crisis—have had much success on this front in just a little over a decade. Central banks have had several decades to eradicate this problem but their success seems limited when compared with that of bitcoin for instance.

Cross border payments or remittances are much faster and cheaper with cryptocurrencies than with traditional payments systems and this might help explain the growing crypto popularity in some parts of Asia and Africa.

So while 69% of the respondents to this survey believe the issue is much to do with a lack of trust, a different survey of non-leading central banks will elicit different results.

Nevertheless, a CBDC— whether retail or a wholesale one—would be a step in the right direction, particularly on the African continent where the financial systems are plagued by inefficiencies and corruption. A CBDC based on the blockchain technology would ensure confidence is restored in the financial system not because users trust those managing the digital currency but they trust the technology.

CBDC restores trust

As observed with bitcoin, cryptography enhances trust in financial institutions or platforms where humans have faltered. Similarly, a retail CBDC that relies on the same cryptography will enjoy guaranteed success. Aside from restoring trust, a CBDC can potentially save central banks money that would otherwise be used to print physical cash.

There are several more reasons why a switch to digital currency makes sense but as OMFIF/IBM report repeatedly states, cryptocurrency growth and popularity are a reflection of flaws in the traditional system of payments. A central bank that genuinely wants to move forward must keep reminding itself why change is necessary and there is no better way than using the results of the OMFIF/IBM report.

  • First, consumer distrust of major financial institutions grew dramatically, as persistent scandals have ravaged the sector. According to analytics group Gallup, only 30% of Americans expressed confidence in banks in June 2018, down almost 30 percentage points from the 2004 peak.
  • Second, trust in central banks has broadly declined in developed economies. In the euro area, net trust in the European Central Bank has declined dramatically and is virtually in negative territory according to the Eurobarometer survey (though a significant majority of citizens express satisfaction with the euro itself).
  • Third, use of cash has declined precipitously in most advanced economies, and in some emerging markets as well. The ratio of cash in circulation to GDP has merely remained stable, if not fallen, in most developed countries, while the value of withdrawals from automated teller machines has similarly stagnated.