The cryptocurrencies as payment methods challenge the CBDC

euro vs bitcoin

We have seen how the industry of payment methods has transformed itself since the cryptocurrencies landed. Both private and public companies have been looking for adaptation to this new environment and the new consumer trends. The digitization of the society and the clearly decreasing use of cash has become a perfect storm for the cryptocurrencies. However, the Central Banks do not want to fall behind and they are studying alternative measures.

Therefore, in this post, we will analyze what is the context where the cryptocurrencies appeared and what is the answer from the financial institutions. Moreover, we will see which are the current CBDC models that are being studied by the Central Banks and how can they affect to Bitcoin and other payment methods.

Current economic context

The most advanced economic systems have been characterized for the last decades by the simultaneous coexistence of private and public payment methods. The Central Banks issued, through the banking system, all the money, and the financial industry was in charge of the distribution to the real economy. This system has worked because it exists a significant link between the banking sector and the real economies (families and small/midsize companies). Additionally, several companies offer private payment methods such as credit cards, etc. This means a clear impulse for the digitization of the economy, creating cheaper and more efficient payment methods.

However, one of the main inconvenience is that everything starts with a decision from the Central Banks. When they decide to reduce the circulation money, the whole system is affected. On the other side, the payment method baked by the Central Banks is the cash money. This method has several implications in terms of privacy and lack of traceability. In fact, this privacy is a reason to be worried about when we talk about money laundering.

Both for people and for financial institutions, the cash money has some other disadvantages. It is not easy to secure due to its physical nature, and it generates huge costs to the Central Banks in terms of issuance and maintenance. For this reasons the use of cash money has experimented a clear decrease in favor of other payment methods such as credit cards, smartphones, etc.

payment methods

Cryptocurrencies as payment methods

With this context, the cryptocurrencies appeared as the payment methods for the future. Bitcoin, as the greatest representative of the cryptocurrencies, was born as a payment method using a disruptive, decentralized and safe technology. In fact, the community asserts that Bitcoin beats all the disadvantages of the current payment methods. The cryptocurrencies do not depend on the Central Banks because of their decentralization, and they remain anonymous on a 100% digital environment. This generates a very attractive alternative to the cash money.

Additionally, we have an scenario where is possible to send transactions with a really cheap cost. These transactions can be sent anywhere and the cost of the technological infrastructure is minimum. Moreover, these transactions are secure, and the system is getting more scalable over time. These are some of the reasons why the cryptocurrencies are a real alternative to the traditional payment methods.

However, there are still several elements which slow down their growth. On one side, the cryptocurrencies use a technology in a very early stage of development, where the scalability is still a challenge. On the other side, the protocol which decides the rhythm of issuance reduces the power of the Central Banks to implement their monetary policy. This policy is one of the most important tools to achieve the goals of economic growth and stability. Because of this, the cryptocurrencies are much more accepted as investment assets than as payment methods.

Appearance of the Central Banks

The worries about this situation has caused that the public financial institutions look for an alternative to the cryptocurrencies. Several Central Banks are studying or developing projects around CBDCs to implement them in the future. It is not a casualty that the CBDCs match in time with the cryptocurrencies. In the last years the need for a public digital alternative to the cash money is getting stronger. In fact, one of the goals of the Central Banks is to guarantee the access to money in a universal and secure way.

However, another important reason for the implementation of the CBDCs are the cryptocurrencies themselves. These imply a universal payment method without any public control and not directly integrated into the traditional financial system. Due to these reasons, the public institutions are worried about these instruments being used as payment methods. The cryptocurrencies are very difficult to trace due to their anonymity and they have no public backup in case of frauds. For these reasons, the CBDCs can become the public and safe cryptocurrencies, using a very similar technology.

cbdc

Possible models for CBDC

The Central Bank Digital Currencies, therefore, make sense within this context. They were born as alterntives to the cash money, but their design allow several very different use cases. According to the report of BBVA Research, there are four different models for CDBC that are currently under study. Depending on their final design, the CBDCs could finally become a good competence for the classic cryptocurrencies, or even just become a public complement for the current financial system.

In that design will be very important to take into account the technical complexity and the goals to be achieved. On the other side, it must be noticed the different implications of this design in terms of responsibility and duties of the Central Banks and the banking system. The independence of these institutions and the governments could be compromised. Therefore, the implications to the cryptocurrencies ecosystem may be also very different.

CBDC for institutional payments

In this model, the CBDC would available just credit entities, so the retail customers would have no access to it. The entities would be clearly identified in the network, which would mean the elimination of the anonymity of the current cash money. This type of CBDC would be focused on improving the efficiency in the wholesale payments system.

The role of the Central Bank would be of just one more participant, but the efficiency would be better, as well as the cross-border character of these operations. The cryptocurrencies were already born without any physical or political barrier, so they are advanced in this sense. Anyway, if the Central Banks would have a real concern in these operations, they may look for a further interoperability among them.

CBDC as replacement of cash

The most intuitive use case of the CBDC would be the replacement of the cash money. This would imply a currency of universal access, anonymous and not generator of interests. It would be of universal access because it should be available for all the citizens within the financial system. It should be, of course, absolutely anonymous to fully replace the current cash money. And last but not least, it should not generate any interests as it would serve only as a payment method.

euro vs bitcoin

This would create a cheaper, safer and cleaner money than cash. However, it is unlikely that the Central Bank finally chooses this design because of the anonymity. The cash money is anonymous because of its own nature, is something intrinsic to it. However, in the case of the CBDC, the anonymity is something programmable in its protocol. Given the current concern about money laundering, tax evasion, etc., it is not logical to stake for this option.

CBDC as tool for monetary policy

The CBDC from the previous scenario would be the perfect replacement for the current cash money. However, the Central Banks could take advantage of the customization of the protocol to design a new tool for their monetary policy. In this case, the CBDC should be very similar to cash money, but it should be able to generate interests. With this characteristic, the Central Banks could be able to intervene with more impact in situations with negative interest rates for example.

This scenario is not frequent although it has been present in the advanced economies during the last years. With this tool the Central Banks would be able to manage the accumulation of money depending on the situation. This is something already done through the banking system, but is not always equally effective. The direct impact on the people’s money would increase the efficiency of these types of measures.

CBDC as mitigator of banking crisis

Last but not least, the CBDC could be universal, not generator of interest and not anonymous. This option would consist on allowing the people to have a direct account on the Central Bank as if it was a commercial bank. The main goal would be to mitigate or even to eliminate the destabilizing character of the banking crisis.

In fact, this option would be equivalent to the replacement of the cash money, but with the users clearly identified. This would allow, on one side, to avoid the anonymity, so uncomfortable for the governments. On the other side, it would create a more efficient alternative to the current cash money. It is also important to have in mind that the lack of anonymity does not means necessarily a lack of privacy. The transactions would remain private among the participants, but they would be identified. The question is, how this CBDC would mitigate the banking crisis?

The key is in the implications on having a direct account in the Central Bank. The commercial banks would have a higher difference between savings and credits, because part of the savings would go to the Central Bank account. Additionally, the people’s may be much safer as the Central Bank has almost no risk of bankruptcy. This option is clearly the most disruptive and innovative, but it implies several risk that must be properly analyzed. In fact, this option would change dramatically the current role of the Central Banks in the economy, so we do not expect a decision like this without further research.

Conclusion

It seems that the CBDC have certain advantages over the cryptocurrencies. However, these advantages come from the fact that they are issued and controlled by a public authority as a Central Bank. This is precisely one of the elements the cryptocurrencies have avoided since their conception. Moreover, every economic area is studying different factors for the development of their currency. Because of this, it will be important to see if there is a coordination of the goals among the countries. In case the Central Banks act independently (which is very likely) the consequences of every CBDC may be quite different.

Additionally, the CBDC are still in a very early stage and very few countries have started with the correspondent tests. If they are finally implemented (it seems so), they probably will not replace the cryptocurrencies, but complement them as alternatives to cash money. Both systems (cryptocurrencies and CBDCs) will probably coexist and the final user will decide how to use each of them.

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