Central Bank Digital Currencies Poised to Be the Foundation of the Financial System, Says BIS

Recent accident, a reminder that the crypto universe has many vulnerabilities

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Central bank digital currencies could make the global financial system more efficient, but their potential could fall short if regulators don’t cooperate, the head of research at the Bank for International Settlements has said.

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“The technology and the technical issues are not that difficult, but once more than one jurisdiction is involved, there are policies and regulations that of course need to be reconciled,” said Hyun Song Shin of the BIS. “What are some of the legal differences between jurisdictions that could mean that smooth flows could be hampered? So there are more of these policy challenges that are really rearing their heads in the wholesale application.”

The BIS, a Swiss-based institution that helps central banks manage their foreign exchange assets, will play a major role in policy discussions that will determine whether central banks join the cryptocurrency business or opt to leave it up to them. of private companies such as Visa Inc. and New York-based blockchain technology company ConsenSys. The BIS is owned by 63 central banks, including the Bank of Canada, and tends to operate as an honest broker between institutions that are subject to very different political influences.

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It has been helping central banks and other financial authorities catch up on the effectiveness of cryptocurrencies, after many were caught off guard by Meta Platforms Inc.’s failed attempt in 2017 to launch a digital exchange unit that could be used in Facebook. . Central bankers and other regulators eventually put down the attempt, intensifying their own investigation into cryptocurrencies in the process.

In the third chapter of the BIS Annual Economic Report Covering digital payments, published June 21, Shin outlined an ongoing wave of innovation that positions central bank digital currencies, or CBDCs, as the future of the monetary system, arguing that the existing crypto universe of bitcoin and multiple stablecoins has structural failures they do is inappropriate and risky. Shin argues that a system built around central bank infrastructure is more stable and interoperable across borders.

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Some challenges remain unresolved, he said, including how many people should have access to retail central bank digital currencies, or CBDCs, which facilitate payments between individual user accounts, as opposed to wholesale CBDCs, which operate between banks. trades for assets such as security. settlements. But perhaps a more challenging issue that will require further fine-tuning is the global regulatory mosaic for digital assets and what degree of regulatory consensus countries can achieve as they explore cross-border payments.

Countries like Canada and the United States have a more lax approach to crypto regulation than jurisdictions like China, which launched a harsh crypto market. crackdown in 2021 which prohibited trading and mining. China is focused on creating its own digital yuan and is often considered the closest country to getting its own CBDC over the finish line, at least among major economies. (Jamaica’s central bank introduced a CBDC in 2020.)

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Canada is one of the pioneers in CBDC research, through initiatives such as Jasper Project in 2016, which explored whether CBDC transactions could be settled on distributed ledger technology. During the fourth phase of the Jasper project, the Bank of Canada, together with Payments Canada, partnered with the Monetary Authority of Singapore and the Bank of England to explore cross-border and cross-currency payments in the Jasper-Ubin project. The developers released a White paper about the project in 2019 that proposed a technical approach to cross-border payments.

Collaborations like Jasper-Ubin led Shin to believe that financial regulators will be able to find common ground in how they each approach cross-border payments, despite differences in jurisdictions and the digital currencies used in each country.

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“We’re pretty sure these things will work,” Shin said. Still, policy differences “will need to be addressed before anything like this is launched in real life and this is where I think it’s very important to have a forum where policy options are discussed and agreed upon,” he said.

Other topics have been entering the CBDC conversation lately, particularly around privacy. While CBDCs could provide more refined tools for tracking data such as inflationShin said it is important to safeguard individual privacy from state surveillance. “We have to safeguard privacy, it is an individual right,” Shin said. “There have to be safeguards… so that individual data is not abused.”

Shin recommended that financial authorities only have access to a minimum amount of information when making debit and credit transactions. “It’s a bit of a double edge: how can you be completely sure that this data won’t be abused?” he said. “So, there will always be that doubt (and) there will inevitably be policy trade-offs here.”

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Another detail that will be double-edged in the launch of CBDCs is how financial services oligopolies in advanced economies will respond to these new innovations.

One argument is that if CBDCs become widely used, commercial banks could be pushed to the sidelines as consumers and businesses transact through networks that support CBDCs. Shin, however, believes this argument is overblown as digital payment innovations have not affected banks’ profit margins.

At the same time, banks have been more enthusiastic on the wholesale side, as innovations in cross-border payments create new business opportunities.

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The main takeaway that Shin noted in his report is that the recent market volatility that caused the bitcoin price to briefly drop below the critical level US$20,000 support level over the weekend is a reminder that the crypto universe has many vulnerabilities. Shin added that its deeper structural shortcomings have been known for some time, so focusing on a digital payment network built on top of an existing, secure central bank framework is why he sees CBDCs as the future of the system. monetary.

“Central banks, as policymakers, it is up to us to really tell it like it is and not be swayed by the latest buzzwords and the latest fad,” Shin said. “But it’s not that we’re just spoilers, we’re saying that there are some useful aspects and the way we put it in the chapter is that there had been a tantalizing glimpse of some of the useful things that people find attractive (with the crypto universe). But all of that can be done using CBDC. (What you can do with cryptocurrency), you can do with CBDC.”

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