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Why Central Bank Digital Currencies Don't Make Sense

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I work in banking but also am interested in cryptocurrencies, which gives rise to an interesting outlook about the future of my industry.


There has been so much furor over Central Bank Digital Currencies lately. After Libra was announced, China also announced that it was intending to launch a digital currency. The USA and Europe then quickly attempted to block Libra from going live, and the IMF encouraged nations to consider issuing their own digital currencies.

Of course, there are also more interesting digital currencies such as Venezuela's Petro dollar, which is supposedly pegged to oil in Venezuela.

The recent announcement that Libra is imploding also raises interesting questions. But at least the central banks do not have to go through any regulators to issue a currency!

The CBDC Structure Doesn't Make Sense

When I started to do more research into whether a Central Bank Digital Currency (CBDC for short) is viable, the whole structure seemed oxymoronic to me. (No, I am not calling them morons—instead, the whole basis seems contradictory, at least theoretically). In my view, there are 3 key areas that seem to undermine the whole notion of a CBDC, at least in theory:

  1. Trust (or the supposed lack thereof)
  2. Centralisation
  3. The fact that it may already exist

1. Trust... or Lack Thereof

Of course, we have to discuss trust first.

Trust is the key assumption in (almost) all of our transactions today. When you make a payment, you trust that the payment will go through, that the product you are buying works, that the money you use and receive as change is legit, etc.

The big contradiction here is that cryptocurrencies like Bitcoin that use blockchain / decentralised ledger technology (DLT) built the system based on the absence of trust, not on the assumption of trust. Thus, the whole concept of the CBDC is called into question because this currency is still a fiat currency. This implies that people still trust that the currency is legal tender and that others will recognise and trust the authority of the central bank issuing that currency.

There is therefore no need for a blockchain or a DLT type of digital currency, because it is already backed by the central bank. So, why then would you even need to build a CBDC using DLT, since it is no different from existing fiat today?

2. Centralisation

Next, the issue of centralisation comes up. The whole point of a CBDC is that it is issued by one central party, and that central party will have control over the currency (which is why it is called a 'central bank', if you missed the memo). Again, this clashes head-on with one of the core tenets of blockchain and DLT, that is decentralisation, which means that no single party will be able to exert control over the currency.

Thus, there is no need to use blockchain or DLT to build this CBDC, because the central bank will want control over this currency, just like the fiat in circulation today. Using blockchain or DLT will just add unnecessary layers and complexity for the central bank that wants to manage this currency.

Speaking from my local point of view, Singapore's central bank/regulator (the Monetary Authority of Singapore, or MAS for short) has already conducted a pilot codenamed 'Project Ubin' where they tested putting the Singapore dollar on the blockchain. It worked, but it was more inefficient compared to the existing system for interbank payments, mainly because each bank had to transfer the total amount of assets over the blockchain and not 'net' the payments off against each other (i.e. netting). Netting is both more efficient and requires less capital outlay.

While this article is not meant to delve into the technical details (you can read their paper for more), the idea is that if two banks owe each other money, they can 'net off' the debits and credits and just settle it in one transaction, instead of bank A having to transfer the full amount it owes to bank B, only for bank B to transfer the full amount it owes to bank A, back.

Thus, a CBDC based on blockchain or DLT will create more inefficiency in domestic payments.

However, there is still potential in cross border payments, and that is something to bear in mind when it comes to CBDC. There are still potential areas where a blockchain-based solution can be more efficient, but only time will tell.

(This is exactly why trade finance is one of the areas where blockchain-based solutions have been taken more seriously.)

3. CBDC Could Already Exist!

Lastly, I am of the view that a form of CBDC already exists, just that governments and central banks don't realise it.

The prime example of this is the US Treasury bond.

To elaborate, it seems that the purpose of the CBDC is to replace 'cash', and to allow people to transact without needing to go through intermediaries like banks. The CBDC would be directly issued by the government/central bank, and it would be in a digital format that represents a claim on the government/central bank itself.

Based on all that, the treasury bond of today would fit the bill quite well. After all, it is already issued in a digital form, it represents a claim on the government equal to its face value, and it is recognised by the people who trade in it as acceptable collateral. Looks at the recent repo issue that the Federal Reserve had to settle.

The only drawback is that it isn't tradable between individuals in smaller denominations, such as a single dollar.

Hence, all the central bank needs to do is to enable the bonds to be tradable in smaller denominations, and voilà, you have a CBDC!

Since I am not privy to how US Treasuries are traded, I will again draw an example from my local context: the Singapore Savings Bond (SSB).

In Singapore, the MAS released a type of bond that is purchasable by the general public and can be used as a long-term liquid investment, the SSB. Every month, the yield on the SSBs to be released that month are pegged to the current Singapore Government Securities yield, and the public can subscribe to the SSBs using their cash in the bank. The SSB is not tradable in the secondary market but can be redeemed at any time (with a processing time of one month) for its face value and accrued interest.

The existing infrastructure in Singapore requires you to open a Central Depository (CDP) account to hold the SSBs on your behalf. So, you don't really hold the SSBs personally, it is being held in your name by the CDP.

Thus, if Singapore wanted to issue a CBDC, all they have to do would be to allow the SSBs to be transferable to another person's CDP account, and split the minimum denomination to $1 instead of the current block of $500. People can then use the SSBs as a cash substitute to do transactions, because the SSBs will continue to pay interest and will still be redeemable at face value, should the person want to redeem it.

"But wait!" I hear you say, "don't the SSBs pay interest every 6 months, and only have a 10-year tenor?"

Well, I do agree with you, my fellow Singaporean who owns some SSBs. But again, the rules for SSBs are determined solely by MAS, who can technically change the rules at its whim. Instead of the structure today, MAS could issue an SSB that has a floating interest rate (to be determined by MAS, as and when they feel like it), and that has no tenor. They can then declare that the existing paper money is no longer legal tender, and that all transactions must be done via SSBs and through the CDP transfer.

And poof, you have a digital currency that will allow the government to charge negative interest rates on (if it so wished, this is for another debate), that isn't based on any blockchain/DLT, and fulfills the main purpose of replacing 'cold, hard (paper) cash'.

Thus, it seems that central banks can issue a CBDC, just by tweaking their existing bonds or treasury notes and not re-inventing the wheel!

But of Course, Life Is Not as Easy as It Seems...

While I would love to use Occam's Razor to justify why a straightforward solution to CBDC should exist, I also recognise that there are likely way more considerations at work here. Monitoring this space should get very interesting very fast, given that China claims to be on the brink of releasing its CBDC into the market (but allegedly, it is only to be used onshore, so again, how is it different from their onshore yuan?).

I look forward to seeing this develop!

This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.

© 2019 Russell


Hansika Motwani on October 18, 2019: