Another day, another dollar

The rise of cryptocurrencies and stablecoins presents fresh challenges for central bankers — does the future hold the prospect of them becoming players in the retail payments business?

Digital currencies have quickly moved from techno- curiosities to heavily traded assets, presenting a conundrum for the institutions that control our financial infrastructure and economy. Tony Richards GAICD, who retired as head of payments policy at the Reserve Bank of Australia (RBA) in December, says developments with cryptocurrencies, stablecoins (cryptocurrencies that peg market value to external references such as money) and CBDCs (central bank digital currencies) have generated the most discussion, conversation and debate in the 10 years he spent at the bank.

Richards, whose job was to understand new payment instruments and technologies, has held small quantities of cryptocurrency, including Bitcoin and Ethereum, since 2014.

He outlined to the Australian Corporate Treasury Association in November how the central bank was responding to the proliferation of digital currencies and the challenge for central bankers to ensure there are safe, stable forms of money that the public can trust.

“There is significant work to be done with the other financial regulators and the Parliament to ensure that Australia has a fit-for-purpose regulatory framework for digital assets,” he said.

One central question is whether the Reserve Bank should issue an Australian digital dollar. CBDCs are a form of digital money that would be backed by a country’s central bank. It is effectively a digital parallel for the physical cash we exchange today. The RBA has investigated CBDC over the past three years to determine how it would be employed, said Richards. CBDCs are much less volatile and more reliable as a store of value than cryptocurrencies such as Bitcoin. They are also more stable than stablecoins — cryptocurrencies where the operator pledges to maintain assets in fiat currency (not backed by a commodity such as gold) equivalent to the coins issued. These claims are sometimes unreliable. In October, the US Commodity Futures Trading Commission found that the largest stablecoin, Tether, only had sufficient fiat reserves to back issued coins 27.6 per cent of the time, fining it US$41m. A retail, or general purpose, CBDC would be like a digital version of cash that is universally accessible, presumably via wallets on phones and possibly via purpose-built devices like smart cards. A wholesale CBDC for financial institutions could facilitate settlement accounts at central banks.

The RBA’s innovation lab developed a proof-of-concept Australian CBDC in 2019 for interbank settlements. The experiment has now expanded to include external parties to explore how it would compare to the existing delivery-versus-payment (DVP) mechanism.

Richards said RBA staff were not convinced to date that a strong policy case has emerged in Australia for a CBDC. Australia’s existing electronic payments system already provides households and businesses with a range of safe, convenient and low-cost payment services. The New Payments Platform (NPP) was a major upgrade to the payments system, allowing real-time, data-rich, 24/7 account- to-account payments. Its capability was highlighted with its use to deliver more than 19 million COVID support payments.

“Much, if not all of the innovation and functionality that could potentially be enabled by a CBDC could in principle also be enabled by innovation based around commercial bank deposit accounts, e-money or stablecoins,” said Richards.

International activity

The US Federal Reserve recently reached the same conclusion on whether to introduce a digital dollar. It published a white paper in January that highlighted the unknown risks and uncertain benefits of a CBDC. “The introduction of a CBDC would represent a highly significant innovation in American money,” the report says. “Accordingly, broad consultation with the general public and key stakeholders is essential.”

One critical aspect of a centralised digital currency is that the central bank — and by extension, government agencies — will have full visibility of every transaction, including the date, amount, receiver, sender and description.

“Central bank digital currencies make perfect sense from a nation state perspective — if it’s just Australia, I’m completely on board with that,” says Jason Potts, distinguished professor of economics at RMIT University and co-director of its Blockchain Innovation Hub. “The problem is that if I need to trade or buy anything from China, then China can now see what I just did.”

China is leading the world with its own CBDC, the digital yuan, which Chinese citizens have used in US$9.7b worth of transactions as of October 2021. Two central banks in the Eastern Caribbean have also launched digital currencies (DCash), while Sweden and Europe are considering proposals, but are unlikely to act in the immediate future.

Competitive risk

Even if central bankers aren’t quite ready to launch CBDCs, they may have little option but to follow through. The greatest risk is not inefficiency, it is irrelevance.

“The network effects inherent in payments could result in large (walled-garden) technology companies or payment schemes coming to dominate the payments industry,” said Richards. One example is the move by Meta (formerly Facebook) to introduce a stablecoin, Diem, to its nearly three billion users. The Diem initiative collapsed in the face of opposition from US and Swiss central banks, and the assets were sold to a Californian bank in January. However, other global technology companies, each with customer bases larger than any country, could follow in its path.

If we do move to a world with currencies from Amazon, Google and Apple, central banks could issue general purpose CBDCs that would allow transfers of various currencies between digital wallets of households and merchants.

“By introducing CBDCs, central banks would not be getting into the retail payments business, but they would be providing a riskless and interoperable form of digital money that could potentially stimulate competition between different private- sector service providers,” said Richards.

Given the possibility that the balance could shift towards a case for issuance of retail CBDCs, the RBA has been stepping up its CBDC research — working on Project Dunbar with central banks from Malaysia, Singapore and South Africa. Project Dunbar aims to develop prototype shared platforms for cross-border transactions using CBDCs of many different jurisdictions. Such platforms could allow financial institutions to transact directly with each other in CBDCs, eliminating the need for intermediaries and potentially improving the speed, cost and transparency of wholesale cross-border transactions, said Richards.

And what about the thousands of cryptocurrencies already in play? How will the the likes of the RBA react to an Aussie Coin stablecoin like the privately owned USD Coin?

A working group involving the RBA and other members of the Council of Financial Regulators, plus AUSTRAC (Australian Transaction Reports and Analysis Centre) and the Australian Competition and Consumer Commission is examining regulatory frameworks for crypto-assets, including national or global stablecoins.

“If stablecoins are intended to be safe payment instruments and serve as alternatives to other forms of money, it is important for consumer protection and financial stability that they are appropriately regulated,” said Richards.