CBDCs, the future of money?

This is the translation of an article I've got published in a newspaper from Argentina called "El Economista" and describes CBDCs and CoChains: https://www.eleconomista.com.ar/2020-04-cbdc-el-futuro-del-dinero/

CBDCs, the future of money?

The launch of CDBCs (central bank digital currencies) is well advanced in several countries. They would allow, for example, to remove the dollars from the mattress and store them in the cell phone.

Last April 7 the Central Bank of England held a webinar to investigate the launch of its CBDC. Similar experiences are taking place in China, France, the United States and many others.

What are CBDCs?

CBDC stands for digital money from the central bank. A CBDC is the cash equivalent but in digital form. Today all the digital money we handle is managed through commercial banks. The idea of ​​the CBDCs would be that your "savings account" was directly in the central bank and one could manage it from a virtual wallet on the cell phone.

Why are they interesting?

These are some of the points mentioned to launch a CBDC: 

  1. They would help eliminate friction in transactions by generating a more resilient system,

  2. They allow them to compete with new forms of money, in particular with the already famous stablecoins such as Libra (pushed by Facebook and company).

  3. It would improve the scenario for greater competition, efficiency and innovation in payment services, 

  4. They would eliminate risks related to the bank in which one has the deposit for being money backed directly by the central bank, 

  5. They would help to eliminate the risk of information asymmetry between banks and others, 

  6. They would allow an improvement in international transactions, 

  7. They would allow a more fluid transmission of monetary policy.

The degrees of progress vary. In China it is said that it would be launched this year and it is already spinning a wallet that is being tested through the state agricultural bank (which “only” has 330 million clients). In the United States the possibility for now seems more distant although the COVID19 situation could accelerate it as a way to eliminate the monstrous current sending of checks.

Are there risks?

The greatest risk or problem of CBDCs mentioned is that of monetary / banking type. It resides in the possibility that banks could lose deposits and therefore funding to grant loans. 

Let's think that today, if you wanted, you could have all your savings in cash, but in part you don't because of the discomfort that would imply. Once a CBDC (central bank digital money) existed, that cost would disappear, creating the risk that a large part of the deposits would be transferred to digital cash.

Regarding whether the cost of funding would rise for banks is quite a separate monetary discussion between those who argue that banks function as intermediaries between savings and investment, and those who prefer to understand banks as agents of the central bank, who ultimately would be the one who funds the credits. For now, let me not get too deep into that.

Does it have something to do with Blockchain?

Not necessarily a CBDC has to be launched on a blockchain. Let's remember that when we talk about Blockchain (technology behind cryptocurrencies like Bitcoin) we are referring to decentralized ledgers that are not managed by any central entity and therefore, eliminate the need to trust a third party.

The central bank of England, in its launch paper, immediately points that its CBDC would probably not run on top of a decentralized blockchain. In principle, if the monetary authority and the unit of account have good credibility, there would be no obvious reason to use them.

There are other cases, however, where it does merit it. For example, the Marshall Islands recently announced that it will launch its CBDC on the Algorand decentralized blockchain. The reason for doing so, in this case, is that they prefer to eliminate the discretionary supply of currency rate by setting it in advance. As it would run on a decentralized blockchain it could not be modified “a piacere” by a central authority. This is Milton Friedman's dream come true.

The Cochains

So far we have two options to launch the CBDC. A centralized one, where the central bank decides and knows everything, similar to what happens today with bank money. And another decentralized one, where whoever designed the CBDC, could define what powers to delegate to the blockchain, such as the speed of issuance or the degree of privacy in transactions.

There is, however, a third option recently launched by Algorand (the same platform that the Marshall Islands chose for its CBDC and which is shaping up to be the one chosen to be used for most transactional digital money launches): The Cochains.

Cochains are a solution that allows you to use both options in parallel. In this way, they would allow the CBDC user to transfer his financial assets from one network to another depending on where he wanted to operate.

Suppose for example, the use of cash in Argentina. A large part of the economy operates in informality and not giving it the possibility of using digital money with the privacy that cash provides today would imply that instead of using the CBDC they will continue to use paper money.

The central bank could give the possibility to move the CBDC from the allowed platform to the decentralized one. It would be the equivalent of today ATM’s withdrawals. Let us remember that we are talking about programmable money, with which a limit could be defined to this “withdrawal” to avoid a massive passage to informality.

Another option where the use of a Cochain would make sense for launching a CBDC could be international financial movements. Suppose an Argentine person wanted to buy an Italian bond. If the Cochain did not exist, that would imply the need to transfer CBDC money to the traditional system, with all the bureaucracy and costs that this entails.

Instead, with a Cochain you could simply buy dollars on the Argentine licensed network (the Cochain), take them out to the decentralized blockchain, and buy the bond securely and in a decentralized way (without having to trust a third party). Remember that every financial asset is liable to be "tokenized" in the same way as money. Tokenizing is, in simple terms, the way to "put" in the blockchain the asset is being tokenized. Instead of the property title being in a centralized entity, such as the stock exchange, tokenization would allow it to be held on a blockchain (without being managed by anyone, so to speak).

CBDCs are advancing steadily and are going to be a reality sooner rather than later. A Cochain allows the best of both worlds. On the one hand, a permitted network, where the central entity does not delegate control of any variable, and a decentralized one that allows operations to be carried out with privacy and without the need to trust a third party.

Gonzalo Martinez Mosquera.

Algorand's ambassador in Argentina.