Blockchain, a revolutionary way of transmitting information trustlessly through time, has captured the imaginations of software developers, economists, and now, central bank policymakers worldwide. Blockchain is a version of distributed ledger technology, a system whose fundamental structure dates back hundreds of years to the Micronesian island of Yap.
In a 2008 whitepaper, Satoshi Nakamoto, to circumvent issues related to the Byzantine Generals’ Problem, suggests that a cryptographic hash function (CHF) can be used as the effective timestamp that tethers blocks of transactions together. This innovation was ultimately used by Nakamoto in the creation of the Bitcoin protocol in 2009.
Stablecoins have emerged as a new way to transact value in the cryptocurrency space. Instead of being claims on network equity, such as Bitcoin, existing stablecoins seek to mimic the price of real-world assets, such as the United States Dollar (USD). A central bank digital currency (CBDC) would effectively be a class of stablecoin.
Motivations for creating CBDCs include an interest in furthering financial inclusion globally, impeding criminal use of cash, improving electronic payments infrastructure, enhancing policy tools, and, in the case of the United States, strengthening the reserve status of the U.S. Dollar. Other CBDCs are likely attempts to offer a different reserve currency option.
There are two main models being suggested for CBDCs: token-based and account-based. Token-based models see CBDCs as a claim on an asset that can be freely transmitted while account-based models suggest all accounts be held at the central bank, which acts as the settling body for electronic entries. That said, the models may be inherently complimentary.
A token-based model seems likely to be necessary to the success of any large-scale CBDC initiative to promote adoption and allow for a true replacement to physical cash. Without a token-based model, central banks are unlikely to displace the desire to utilize cryptocurrencies in our view.
A true CBDC launch among Western countries seems unlikely to occur anytime soon. The head of the European Central Bank, Christine Lagarde, suggested that it could take anywhere from two to four years.
Regarding U.S. efforts, a number of Federal Reserve speeches and publications have been presented this past year on the matter, likely due to the increased focus on digital payment systems caused by the COVID-19 pandemic.
China is expected to be the first major sovereign power to implement a large scale CBDC initiative, further expanding the footprint of its digital economy and potentially laying the foundation for at least partial yuanization of countries along the Belt and Road.