The Week - UK (2021-07-17)

Briefing NEWS 13

17 July 2021 THE WEEK

Whatexactlyaregovcoins?
Althoughstilllargelyhypothetical,they
areconsideredbysometobethemost
importantfinancialinnovationsincethe
inventionofbanknotes.Formallyknown
ascentralbankdigitalcurrencies
(CBDCs),theyarelegaltenderin
electronicform–andwouldbetied
penny-for-pennytoestablishedcurrencies
suchassterling,thedollarandtheeuro.
Onlyonebigeconomy,China,hassofar
conductedlivetrials;however,nearly
90%oftheworld’scentralbankshave
launchedexploratoryprojects,according
totheBankforInternationalSettlements,
withSweden’s“e-krona”andthe
Bahamas’“SandDollar”outinfront.In
April,theUKChancellor,RishiSunak,
setupataskforcetoexaminetheviability
ofadigitalpound,or“Britcoin”.

Howwouldtheydifferfromcryptocurrencies?
Insomeways,they wouldbesimilar:imagine bitcoin, ifbitcoin
weremanaged bytheBankofEngland andbackedbythe
Government.Electronicversions ofcurrencyalreadypredominate
inmost financialsystems. However,theelectronic depositsand
digitalaccountsusedbynormalcustomersareprivatelymanaged
bycommercialbanks;centralbankshavetheirownreservesof
digitalmoney,buttheymostlyonlysupplyittoother banks.The
most far-reachingversionofaCBDC wouldmeanthat,instead of
holdinganaccountwitharetailbank,youcould do sodirectly
withacentralbank. Ratherthanpayingwith acard,youcould
usethecentralbank’ssystem–perhaps throughanappsimilarto
PayPalorApplePay.TheBankofEnglandthinksthatCBDCs
would “existalongsidecashandbankdeposits,ratherthan
replacingthem”,butevenso,itwouldbearevolutionarystep.

What’sdrivingtheseexperiments?
Thefastdeclineof cash,andthe challengetothemonetarysystem
posedbycryptocurrencies.Bitcoin’s emergence asamainstream,
if highlyvolatile,$1trnassetclasshaspersuadedmanyother
playerstojoin the game.There arenownumerous alternatives to
bitcoin–“altcoins”suchasethereum andmonero –alongwith
“stablecoins”, whichtry toreducethe
investment risk ofcryptocurrencies
bypeggingthemto acurrencyor
commodity:USDCoinispegged to
the dollar, Glint to the price of gold.
Central banksareparticularly
concerned by Facebook’splan fo ra
private digitalcurr ency calledDiem
(formerlyLibr a). Governmentsfear
tha tthe anonymityoffere dbythese
currencies willincreasinglybeused
for illegalpurposes andthat, being
unregulated, theycould undermine
the stabilityof th efinancial system.
China(once acentre of bitcoin
trading) hasnow prohibitedbanks
andpayment firmsfrom facilitating
cryp to-transactions. And some central
bankers have concluded that they
mustjoin the game bycreating their
owncurrencies, or risklosing control.

What are the advantages?
Proponentscite al lkinds of benefits:
CBDCs couldcreateabetter financial

system.Today’sbanks are expensive(we

payanaverageof £ 150 peryearinfees)

and theysometimes fail.Theyalso

exclude many:eveninthe UK,1.

million are thoughtto be“unbanked”.

Govcoinswouldallow thecreationof

faster,safer,cheaperpayment systems–

particularlyusefulin nationswithlarge

numbersofunbankedcitizens.Since

every currencyunitcouldbetracked,

CBDCswouldbe apowerfuldeterrentto

taxevasion, moneylaundering andother

financial crimes. Govcoinscould also

transformmonetarypolicy. E-accounts

would givecentral banksmoreprecise

controloversystemicrisksandthe

moneysupplythancurrent toolssuchas

interestrates–enablingthemto“nudge”

economicbehaviour.InChina’srecent

trial,e-yuanwereprogrammed withan

expirydate,toencourageimmediatespending.

Andthe downsides?

CBDCsraisemajorconcerns aboutdata privacyandexcessive

statecontrol. Withoutsafeguards,theunprecedentedpower

conferredbydigitalcurrencies –potentially,toseeeverypurchase

–couldturn centralbanksintoafinancialBig Brother.TheBank

of Englandhassuggested that govcoinscouldbe designedto give

adegreeof privacy,particularlyifintermediaries (most likely

domesticbanks)provided“payment interfaces”.But thatmaynot

satisfy thoseconcernedaboutthedegreeof governmentcontrol

(accountscouldbe shutdownat the tapof abutton)andstate

surveillance–notjust ofbank balances but,because ofthe

transaction trail,ofpeople’sentire financialhistories.

Whatotherobjectionsarethereto CBDCs?

Environmentalistspointto the obsceneamountof energy used by

bitcoin’sblockchaintechnology(thedigitalledgersystemused to

verifyownership).Studies suggestitconsumesasmuch electricity

as amedium-sizedEuropeancountry. CBDCscould,intheory,

be muchmoreefficient,butthathasyettobe proved.Thecrypto-

finance industryisalsoup inarms.Whenthe Britcoin projectwas

announced,JasonCozensofGlint argued that theBankof

England was“lookingto control,or

better yet,crush theriseofalternative

currencies”.Mainstreambanks are

alsoveryconcerned byCBDCs.

Why are banks worried?

Govcoinscould pose an existential

threat to commercialbanks. Why

wouldanyone useahigh-streetbank

if centralbanks were toprovidethe

same service, more cheaply and

safely? Andifb anks’ depositswere

reduced,thefinancialsystemwould

be greatly changed:bankswould

have lesstoinvest in mortgagesand

theeconomy. Digital currenciesare

sure todevelop, but depending on

whichversionswin out, the“revol-

utioncould go in twodirections”,

says Prof R andall Krosznerofthe

Uni versity of ChicagoBooth School

of Business –“eith er atriumphof

decentralisation andmarket forces,

or atriumphof centr alisation and

governmentmonitoring”.

Govcoins: the coming revolution?

Governmentsaremullingover whetherto introducetheirown digital currencies,also knownasgovcoins

Livetrialsofe-yuanareunderwayinChina

The evolution ofmoney

Money hasanumber of overlapping roles: as a

medium of exchange (for payments), asastore of

value (for savings and investment), and asaunitof

account (for measuring value). It allowed societies to

move beyond barter, separating buying from selling.

The earliest forms of money were rare and precious

objects: cowrie shells, pearls, gold, silver, cows. They

allowed societies to move beyond barter, separating

buying from selling. Paper money dates to 13th

century China: Marco Polo noted with amazement

that these “pieces of paper are issued with as

much solemnity and authority as if they were of

pure gold or silver”.

Precious coins and the like are known as “commodity

money”; today’s currency as “fiat money”, because it

becomes legal tender by government order. These

technical distinctions still have significance. The cash

in your pocket is legal tender; the pounds in your bank

account are not. If your bank fails, you will only reclaim

the amount guaranteed by the Government (£85,

per bank). By contrast, CBDCs would be legal tender.

So far, cryptocurrencies have proved impressive as a

store of value, but useless asameans of exchange.

CBDCs, however, could perform both functions.