DFC

G7 Finance Ministers and Central Bank Governors remain focused on central bank digital currency (CBDC) and global stablcoins.

The Bank of England published a discussion paper that set out its emerging thoughts on new forms of digital money, which include both systemic stablecoins and a UK central bank digital currency (CBDC). It builds on the Bank’s previous Discussion Paper on CBDC published in March 2020 and the Financial Policy Committee’s expectations for stablecoins set out in the December 2019 Financial Stability Report. Broadly speaking, the paper proposes that stablecoins should meet equivalent standards to those imposed on commercial banks.

"Central banks can support the development of digital currencies indirectly, by supporting the public provision of safe, privately issued digital currencies, or more directly, by issuing digital currencies themselves, among other possibilities. These approaches are not necessarily mutually exclusive, especially if there are separate reasons to issue a CBDC. In that case, central banks may need to think about how private sector entities could use the CBDC to support the development of their own stablecoins."

El Salvador’s government is reportedly planning to release a U.S. dollar stablecoin. The currency would be issued by the central bank, pegged to the value of the U.S. dollar and backed by reserves of real U.S. dollars. The cryptocurrency would be called the “Colón-Dollar,” a reference to the country's former national currency that was replaced with the U.S. dollar in 2001. The president’s brothers reportedly met with representatives from Cardano, WhizGrid and Algorand at different times.

"As for the consumer benefit of private versus public money, one only has to consider what happened after the free banking episode in the U.S. Monetary issuance was centralized in the hands of the state, which promptly inflated away everyone’s savings during the Civil War. Curiously, the central bankers touting the benefits of public money omit that part of the story. "

According to this paper by Diem/Novi's Christian Catalini and Andrew Lilley there are at least three ways to remove frictions in payments and rapidly expand the number of individuals and businesses that can access the financial system and cheaply transact in real time. The first is to bring deposits on a single ledger through a central bank digital currency (CBDC), so that transfers between banks are not limited by external liquidity constraints or third-party rails. The second approach is to follow countries such as India and Mexico and increase the throughput of always-on real-time gross settlement (RTGS) systems, the model the US Federal Reserve is pursuing with the introduction of FedNow, targeted for 2023. The third approach is to facilitate the growth of interoperable, stablecoin payment rails by creating the right regulatory framework for these new types of networks to safely increase competition in payments.

U.S. Federal Reserve Governor Lael Brainard reportedly laid out a range of reasons for "urgency" around the issue of developing a U.S. central bank digital currency (CBDC), including the fact that other countries such as China are moving ahead with their own. "The dollar is very dominant in international payments, and if you have the other major jurisdictions in the world with a digital currency, a CBDC offering, and the U.S. doesn't have one, I just, I can't wrap my head around that... That just doesn't sound like a sustainable future to me." She also pointed to the risk of stablecoins proliferating and fragmenting the payment system.

"A more practical and efficient method of backing a privately-issued stablecoin, discussed in detail in our “Shaping the Future of Digital Currencies” report, would be to replace (off-chain) central bank reserves with an (on-chain) central bank blockchain-based liability, or CBBL for short."

Visa published a paper on its "universal payments channel" (UPC) that will facilitate transactions between various stablecoins and central bank digital currencies (CBDCs). Specifically, it proposes a hub-and-spoke payment route that can be used to support digital token transfers of funds across different networks through payment channels. The UPC protocol facilitates payments through a "UPC hub" that acts as a gateway to receive payment requests from registered sending parties and routes them to registered recipient parties.

"Without access to central bank payment rails, non-bank stablecoins will be perceived (however large the HQLA buffers they may propose) to be less safe than bank stablecoins. As most stablecoins are in US dollars, the US has an opportunity to exploit its (relatively) late entry into the stablecoins discussion. Allowing stablecoins from banks and non-banks chartered as banks to interoperate – not just by enabling both to have access to central bank payment systems, but also by enabling the use of public, open-source technology protocols that already interoperate with each other – will make a difference in the payments/settlements landscape."

The Republic of Palau has partnered with Ripple to develop a U.S. dollar-backed digital currency for the country using the XRP Ledger. If launched, it could be the world’s first government-based national stablecoin (GovCoin). (The Pacific island nation has no central bank and uses the U.S. dollar as its official currency, so a central bank digital currency (CBDC) is out of the question.) The IMF hasn't opined on this yet, but it was only a month ago that it completed its 2021 Article IV mission and no mention was made of any such development.

A new C.D. Howe Institute report advocates for the Bank of Canada issuing central bank digital currency (CBDC) to facilitate the emergence of Canadian dollar stablecoins. The report explains that Canadian-dollar-linked stablecoins could become attractive to Canadians by making them convertible into Bank-issued cash, and ensuring that the stablecoins are well designed and regulated from business conduct, competitive, operational, privacy and prudential perspectives.

The Bank of England dismissed the option of a domestic wholesale CBDC, because the private sector can achieve a similar result themselves. Governor Bailey, at a UK House of Lords Economic Committee meeting, highlighted that banks have existing access to central bank money through its real time gross settlement system. Also, the Bank has introduced an omnibus account that would enable the banks to use digital coins between themselves that settle with the Bank of England. It might also allow nonbanks, like Fnality, to create wholesale digital currency backed by central bank money

Visa's research and product teams are working on a universal payment channel (UPC) initiative, a blockchain interoperability hub that connects blockchain networks and allows for transfers of digital assets. The UPC hub would connect different blockchain networks by establishing dedicated payment channels between them — whether that means connecting central bank digital currency (CBDC) networks between countries or connecting CBDC networks with vetted private stablecoin networks. New, trusted blockchains could easily be added to the network of networks by creating new payment channels within the UPC hub.

"Earlier this year, I spoke about whether the Fed should offer a general-purpose central bank digital currency (CBDC) to the American public. My skepticism about the need for a CBDC, which I still hold, comes in part from the real and rapid innovation taking place in payments. My argument—simple as it sounds—is that payments innovation, and the competition it brings, is good for consumers. The market and the public are telling us there is room for improvement in the U.S. payment system. We should take that message to heart and provide a safe and sound way for those improvements to occur."

The International Securities Services Association (ISSA) published a paper on the potential application of central bank digital currency (CBDC), and to a lesser extent stablecoins, in the existing and future capital markets post-trade landscape, with a specific focus on the value chain in securities settlement arrangements. It provides a broad overview of key use cases, opportunities, and considerations for market infrastructures, custodians, intermediaries and service providers to consider. In addition, it provides an outline of the roles (including the possible changes of current roles), challenges, opportunities and potential changes that the impact of CBDC and stablecoins could have on the banking, fintech, and securities industry.

While Gorton and Zhang, and the IMF, have the right idea of building a public/private partnership by backing privately issued stablecoins with a central bank liability (e.g. reserves), they picked the wrong liability — or at least the wrong version. A more practical and efficient method of backing a privately-issued stablecoin would be to replace (off-chain) central bank reserves with an (on-chain) central bank blockchain-based liability, or CBBL for short. Another way of thinking about a CBBL is it’s effectively a tokenized form of the trust we have in central banks, but it’s more efficient, transparent, and accessible than traditional central bank reserves.

"The writing is on the wall: Cryptocurrencies are likely going to play a significant role in the future financial system. The U.S. Federal Reserve has called for a comprehensive regulatory framework for stablecoins and is exploring a central bank digital currency. While a complete overhaul of the system of money is an extremely complex endeavor, there are three measured approaches — different, but not incompatible — that have serious potential: 1) true stablecoins, which are non-interest bearing coins designed to have stable value against a reference currency; 2) demand coins, which are demand deposit claims against insured commercial banks, on blockchain rails; and 3) central bank digital currencies, which are cash on digital rails and could represent the public sector’s response to decreasing demand for physical cash.c"

This article makes a case for community (or complementary) currency backed by a central bank digital currency (CBDC) to democratize money creation. The authors show that community currencies can have higher multiplier effects on local expenditure, allow central banks to control circulation velocity, and help countries in currency crises. For example, communities can build smart contracts into their currencies, incentives to “nudge” users toward green services and other pro-social expenditures.

This paper, co-authored by the European Central Bank's Ulrich Bindseil, describes current potential "holy grail" ways to cheap cross-border payments that settle immediately in a secure settlement medium. It concludes that several solutions are suitable and some may even be the holy grail.

"Money doesn’t have to be legal tender to be used for mainstream payments. It just needs to be widely accepted. Making stablecoins legal tender may help to instill confidence in them, but far more important is regulating them so they are perceived as safe. The U.K. has a comprehensive system of regulation to ensure that electronic payments are safe. Bringing stablecoins into this system of regulation would encourage their widespread use."

The Bank of England's Andrew Hauser argues that a central bank digital currency (CBDC) could have a big impact on the the size, composition and risk profile of the central bank's balance sheets; for the monetary policy transmission mechanism, and for monetary control. He argues for the need to understand these impacts, and build them into the design of CBDCs and central bank operational toolkits.

"Small businesses have largely been ignored during the debate over digital currencies, even though they’re a hugely significant part of the U.S. economy and have much to gain from cheaper, more efficient payment systems. These businesses work with small margins, have less bargaining power than large companies, and suffer from cash flow problems as they wait to be paid for goods and services. Stablecoins and central bank digital currencies can help. These technologies can reduce payment processing costs, allowing small businesses to keep more of what they earn, and significantly accelerate how quickly they get paid. This could drastically improve small businesses’ liquidity and cash buffers, and help them survive negative economic shocks and thrive."

"The ongoing digital revolution may lead to a radical departure from the traditional model of monetary exchange. We may see an unbundling of the separate roles of money, creating fiercer competition among specialized currencies. On the other hand, digital currencies associated with large platform ecosystems may lead to a re-bundling of money in which payment services are packaged with an array of data services, encouraging differentiation but discouraging interoperability between platforms. Digital currencies may also cause an upheaval of the international monetary system: countries that are socially or digitally integrated with their neighbors may face digital dollarization, and the prevalence of systemically important platforms could lead to the emergence of digital currency areas that transcend national borders. Central bank digital currency (CBDC) ensures that public money remains a relevant unit of account."

"Stablecoins and central bank digital currencies are on the horizon in Asia, and in some cases have already arrived. This paper provides new analysis and a critique of the use case for both forms of digital currency. It provides time-varying estimates of devaluation risk for the leading stablecoin, Tether, using data from the futures market. It describes the formidable obstacles to widespread use of central bank digital currencies in cross-border transactions, the context in which their utility is arguably greatest. The bottom line is that significant uncertainties continue to dog the region's digital currency initiatives."

The Richmond Fed published an article that discusses the question of whether a regulatory framework for stablecoins — where regulated banks can issue stablecoins backed 100% by deposits at the central bank — could serve as an alternative to issuing central bank digital currencies (CBDCs). It concludes that appropriate regulation may offer a path whereby stablecoins become effectively equivalent to CBDCs — when they are issued by regulated institutions and backed by reserves.

"This paper offers a discussion on the challenges analysts, technicians, and interested members of the public face when discussing how interoperation in a payment system can support goals of efficiency, security, and accessibility. We deconstructed elements of the payment system and defined these elements to support a deeper analysis of where and how the term interoperation can be appropriately applied. The fit-for-purpose framework offers a simple, four-step approach to increasing the depth and clarity of discussions about payment system interoperability and how it may be used as a tool to support various goals. The approach focuses on defining the boundaries of a system within the context of the discussion, adopting common terminology, describing the degree of interoperation required, based on agreed-upon descriptions, and mapping the current state of existing structures (where applicable). Finally, we sketched preliminary results of a hypothetical discussion where participants used our framework to discuss the topic of interoperation with respect to how a potential CBDC and stablecoins could technically co-exist in payment systems."

The European Central Bank (ECB) published a paper that describes current visions of how to eventually find the holy grail of immediate, cheap, universal cross-border payments settled in a secure settlement medium. It focuses on six potential solutions; (i) modernized correspondent banking; (ii) emerging cross-border FinTech solutions; (iii) Bitcoin; (iv) global stablecoins; (v) interlinked instant payment systems with FX conversion layer; (vi) interlinked CBDC with FX conversion layer. For each, settlement mechanics are explained, and an assessment is provided on its potential to be the holy grail of cross-border payments. Several solutions are suitable for improving cross-border payments significantly, and some could even be the holy grail.

"In the two-country model in Benigno, Schilling & Uhlig (2022), the usage of a privately-issued crypto-asset as a global means of payment leads to the enforced synchronization of nominal interest rates, and hence to a loss of monetary policy autonomy. This paper shows that the same result obtains in a world in which central banks issue digital currencies (CBDC) to be used abroad. In that case, shock transmission is symmetric, whereas it is asymmetric if only one country issues international CBDC or crypto-assets are tied to one currency (stablecoin)."