Will central banks issue cryptocurrencies?

BBVA's Head of Global Economics, Regulation and Public Affairs analyzed how DLT (Distributed Ledger Technology) — the technology that enables virtual currencies, among other innovations — has expanded its presence in recent years. This technology enables the exchange of money without a centralized intermediary. In González-Páramo’s opinion, this represents the first requirement for the complete digitalization of physical money.

This debate was part of the tenth annual conference organized by the central bank of Peru and the Reinventing Bretton Woods Committee which took place in Valle Sagrado in the heart of Cuzco, Peru.

Four potential central bank cryptocurrency scenarios

Hard cash has three specific characteristics: it is universally accessible, the person who owns or trades it is anonymous, and it is zero return – cash itself gives no return.  José Manuel González-Páramo used these attributes to analyze four approaches central banks might take to issuing virtual currencies. Each scenario has the potential to achieve a different monetary policy objective.

1. First, an approach using cryptocurrencies to improve the interbank market was described. In this method, blockchain would only be used in wholesale payment systems resulting in 24/7 availability, without interruption, as opposed to the current system called RTGS (Real Time Gross Settlement). Greater speed and lower management fees would contribute to the increased efficiency of this system. The cost of adding a new player would drop significantly, increasing accessibility and promoting competition.Does this approach retain qualities of physical money? Targeting the wholesale market exclusively, it would not offer universal access, and in principle it would not be anonymous.
2. Secondly, the global payment system could be improved. In other words: a pure alternative to cash, where banks would create money and they would maintain exclusivity in keeping reserves in the central bank. All the advantages of cash would be applied to the digital domain: universal access, anonymity, and zero return. In this scenario, José Manuel González-Páramo explained, retail payment efficiency would improve, but critical questions about security and the development of informal markets arise. Additionally, it would impact international flows; hence the authorities have demonstrated little interest in this approach despite it being the best replica of physical cash, according to BBVA's executive board member.
3. The third scenario envisages cryptocurrencies used by the central banks as a monetary policy tool, something that seems interesting in theory, but not very practical given the numerous risks. DLT technology could enable the central bank to alter the nominal value of the “stock” of virtual currencies, which would transform it into an interest bearing currency. This would be a revolutionary change, providing monetary policy options that are currently not available. In this scenario, cryptocurrencies would continue to be universally available and provide anonymity to users. Additionally, reducing the nominal value of the currency would equate to setting negative interest rates without restriction, which would call into question the central banks themselves, declared González-Páramo.
4. The fourth scenario would pursue a goal of greater vigilance and/or the reduction of systemic financial risk. Cryptocurrencies would be identifiable: universally accessible and with zero return, but not anonymous. They would be more like a replacement for bank deposits than physical cash.  The positive side, a method where users are identifiable is more secure. In addition, the loss of anonymity would help with another goal of the advocates of this approach: control against illegal activities/informal market businesses. Nonetheless, it would entail considerable change to the current financial system, putting commercial banks and a good portion of credit providers at risk, institutions which are key to any modern economy.

Which scenario is most likely?

José Manuel González-Páramo expects that the least disruptive scenarios, specifically the first approach, are the most likely given their ease of implementation, lower costs, and less uncertainty on the part of the authorities. BBVA’s board member believes analysis and debate is still required to understand cryptocurrencies issued by central banks. In his opinion, many countries would benefit, especially those in emerging markets.

He also stressed topics he believes deserve greater attention in the years ahead: quantifying the impact of virtual currencies used by central banks (CBDC) in each scenario and considering the impact of these virtual currencies in an international context: How will cryptocurrencies issued by the different national central banks interact?