Will Central Banks Ruin Crypto? | Blockchain Central

Will Central Banks Ruin Crypto? | Blockchain Central

Hi guys, thanks for tuning in to another episode
of Blockchain Central. My name is Blu and in todays episode we’re
going see how Central Banks are feeling about Crypto. As usual, please note that this content does
neither represent financial, legal, or tax advice, nor is it supposed to be understood
or interpreted as solicitation to buy or sell any securities, coins or tokens. Ever since the emergence of Bitcoin and other
cryptocurrencies, the future of money and the financial system as we know it today has
been a hot topic for debate. While venture capitalists and financial institutions
invest heavily in the DLT space, the question remained whether it’s a good idea for sovereign
states and central banks to do so as well. In fact, a couple of central banks have dipped
their toes into the uncharted waters of cryptocurrencies and experimented with possible technologies
and frameworks for various use cases. Also, in countries like Sweden and Switzerland,
the use of cash as means of payment has declined over the last couple of years, so it seems
to be about time for a digital alternative. But before we explore what it takes for Central
Banks to adopt Crypto, let’s first dig into the different forms of money present within
the the traditional financial system their characteristics. When we talk about money, we typically refer
to cash, which consists of coins and banknotes. Well, actually, there are a few more options. One of them is so-called commodity money. Like cash, it is linked to physical objects
that are used for payment, such as gold. The main difference is that commodity money
is not issued and controlled by the central bank just like good old cash, but it still
can be used for payments by parties that accept it. Apart from physical objects that represent
money, from an economic point of view, the money supply also includes forms of bank money,
which consists of electronic account records. These are essentially just the balances held
in checking, savings, and other types of bank accounts that exist only virtually without
any physical shape. Think of mobile money, bank deposits or settlement
accounts, for instance. In fact, currently more than 80% of the money
in our financial system exists only in the digital form. And that’s one of the reasons why cryptocurrencies
kind of make sense for central banks! When we look at all these different forms
of money, though, it is important to distinguish between the retail side and the wholesale
side. The retail side is the one we’re most familiar
with, because it reflects the payments and transactions made by the general public. The wholesale side, on the other hand, refers
to the wholesale payment applications between institutions. If a central bank wanted to introduce a cryptocurrency
for the retail side, it would mostly compare its advantages and disadvantages to cash. If it wanted to introduce a cryptocurrency
for the wholesale side, it would probably mostly compare it to central bank settlement
accounts. Now, to better understand the main requirements
of each side, let’s look at some properties of retail and wholesale money, using cash
and settlement accounts as examples. Cash is issued by the central bank, has a
physical form (coins and banknotes), is universally accessible and is transferred through peer-to-peer
transactions. As such, cash offers the benefits of being
a decentralized means of payment, universally accepted, as well as anonymous and without
any settlement risk. The last point just means that once I receive
cash from someone, the transaction is settled without any delay, unlike a bank transfer. These aspects would have to be met or improved
if a central bank were to issue a consumer-facing retail cryptocurrency. On the wholesale side, things look a little
different. The settlement accounts are issued or administered
by the central bank, exist only as electronic ledgers, are accessible only to dedicated
financial institutions and are transferred through a central operator, who can also see
all of the transactions in detail. So, in contrast to the retail side, anonymity
and universal availability do not play a significant part in wholesale transactions. Here, the introduction of blockchain-based
central bank crypto currencies would have to offer benefits in terms of improved efficiency
and reduced settlement cost, when compared to the current infrastructure. Now we can actually see that introducing a
central-bank-hosted cryptocurrency is not necessarily a straight-forward decision, even
though it might seem obvious at first. Several ideas have already been suggested,
but all projects are still in experimental stages or exist as prototypes. Perhaps one of the most discussed proposals
for a retail central bank cryptocurrency is Fedcoin. The idea is for the US Federal Reserve to
create a cryptocurrency that is similar to bitcoin, but–unlike bitcoin–only the Federal
Reserve would be able to create Fedcoins and there would be one-to-one convertibility into
cash and reserves. Like cash, Fedcoin would be decentralized
in transactions and centralized in supply. In a similar project, the Swedish Riksbank,
has pondered introducing the eKrona as a retail central bank cryptocurrency. The advantage of Central Bank CryptoCurrencies,
or CBCC’s similar to Fedcoin for retail would be the elimination of the elevated price-volatility
that we currently observe in the crypto space. Moreover, Fedcoin has the potential to relieve
the zero lower bound constraint, an issue that limits the ability of a Central Bank
to stimultae economic growth. So far so good, but there one reason why a
central bank would be careful to go ahead with Fedcoins or eKronas: namely concerns
over the protection of anonymity or privacy of consumers. Storing all transactions on a shared ledger
may leave users’ activities and spending behavior fully exposed to those parties which
are permitted to manage it. On the other hand, granting users full anonymity
opens the door to criminal activities like money laundering or tax evasion. So, it’s a fine balancing act to determine
whether and how much customer information to collect and how to fine-tune access control. While CBCCs for retail payments are still
mostly just thought experiments, some central banks have completed proofs of concept for
DLT-based applications. Part of the story why wholesale CBCCs are
so interesting is that many central bank-operated wholesale payment systems are at the end of
their technological life cycles: programmed in obsolete languages and using old and costly
database designs. Another major point is that wholesale CBCCs
have significant potential to increase efficiency and reduce costs of clearing and settlement
of securities. Therefore, processes that currently take days
to settle, could be done almost immediately at a fraction of the cost. However, the two main challenges for introducing
CBCCs for wholesale are: how to transfer central bank money to the distributed ledger and lack
of understanding what impact and side-effects this could have on commercial bank balance
sheets, credit, liquidity, and other economic variables. Let’s recap the main points. First, you have to distinguish between the
retail side and the wholesale side. Retail CBCCs could essentially function as
an electronic and convenient substitute for cash with basically all its main properties. However, the question of user anonymity and
balancing between privacy protection and fighting crime is one that needs to be addressed. Wholesale CBCCs would make a lot of sense
because they have the potential to significantly improve the speed and efficiency of transaction
handling of current settlement systems used by central banks. The problem is just that it is not yet entirely
clear of how to transfer central bank money to a distributed ledger and what other economic
effects the introduction of retail and wholesale CBCCs would have on the financial system. So, we’ll probably still have to wait a
little longer before we see the introduction of central bank cryptocurrencies – at least
as an everyday substitute for cash that we can use. That’s it for this episode of Blockchain
central, let me know in the comments if you think central banks will ever adopt crypto
and, as always, make sure to hit that like button if you liked this video and don’t
forget to subscribe to Blockchain Central to never miss a beat! Happy investing!

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About the Author: Maximilian Kuhn

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