IBM report: 1 in 3 central banks are trialing a digital currency

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A report co-authored by IBM and the OMFIF has revealed that central banks are continuing to maintain their distance from the cryptocurrency sector - but are working on creating their own digital currency offerings, albeit at a slow pace.

The Official Monetary and Financial Institutions Forum (OMFIF) is an independent think tank for central banking, economic policy, and public investment. The “Central Bank Digital Currencies” report provides valuable insights into the perception of bitcoin and its peers, especially with regard to central banks and other traditional financial institutions.

The report surveyed 21 central banks between July and September 2018. 38 percent of respondents originated from institutions researching and trialing wholesale CBDCs. 62 percent of the respondents, however, were not actively pursuing this course of action.

What do central banks stand to gain?

While digital currencies have created a lucrative industry that continues to grow its reach, traditional financial institutions have handled them with varying degrees of both interest and disdain.

Jesse Lund, Vice-President of IBM Blockchain, says that traditional financial institutions are not able to ignore cryptocurrencies forever and would be looking to reap the benefits of digital currencies in a safe and secure manner. “The observed benefits are compelling: improved trust between counterparties, increased regulatory transparency, tax collection benefits, reduced fees, and financial statement risk. There are still many details to sort out, but cryptocurrencies are here to stay, and so we endeavor to apply the same benefits to fiat currency issuance without sacrificing traditional monetary policy, enhanced due diligence, and other compliance controls.”

However, there is a history of antagonism between traditional financial institutions and the digital currency sector. A core fundamental of cryptocurrencies is that they are designed to be decentralized. This feature puts them at odds with central banks which need to have control to ensure security and speed. Nonetheless, some central banks are investigating their own central bank digital currencies (CBDCs).

There are two kinds of CBDCs: retail and wholesale. The Deputy Chairman of OMFIF, Philip Middleton, says that a third of the central banks included in the survey were dedicating resources to create these offerings. “Despite – or perhaps because of – dispelling this threat to their authority, many of the world’s leading central banks have devoted considerable effort to examining the viability of introducing digital fiat currency as a complement or indeed a replacement for physical cash.”

Wholesale CBDCs is what banks would use to transact between each other - while retail CBDCs would give provide everybody the right to hold a fiat currency-backed digital currency issued by a bank. The supply for wholesale CBDCs would be limited only to certain banks to facilitate interbank settlements.

What is certain is that central banks are not in favor of creating and releasing any CBDCs for the public because retail CBDCs come with a host of operational challenges, the topmost of these being security and regulatory support.

Says Lund: “Most have concluded that, although such an introduction could deliver benefits in both payments system efficiency and the exercise of monetary policy, now is not the time, for a variety of practical and policy reasons, to proceed with a retail central bank digital currency.”

However, while no major central bank intends to implement a retail CBDC in the near term, the debate about wholesale CBDCs has progressed and preliminary testing performed by banks trialing CBDCs, there have been positive results.

Wholesale CBDCs dominate but not in play any time soon

According to the survey, wholesale CBDCs are a popular choice for banks because they are able to solve some of the operational challenges that banks are facing with their legacy systems. “One of the reasons for the interest in DLT is that many central bank-operated wholesale payment systems are at the end of their technological life cycles. The systems are programmed in obsolete languages or use database designs that are no longer fit for purpose and are costly to maintain.”

Wholesale CBDCs use distributed ledger technology but due to their restricted nature are able to preserve much o the control that central banks need. Moreover, wholesale CBDCs would have no significant monetary policy implications. This is important for central banks as they must stay within global financial regulations.

Additionally, further alterations could be made to a CBDC to exalt it globally, if need be. “According to central bank respondents, a wholesale CBDC would be designed simply as a digital reserve. This model would have limited repercussions on policy-making. A wholesale CBDC could be expanded to serve as a digital global reserve asset along the lines of the International Monetary Fund’s special drawing right.”

While wholesale CBDCs are a possibility, the report states that “none of the central bank case studies examined included the possibility of radically overhauling their payments systems in the near future. Most are satisfied with existing RTGS platforms.”

The report includes case studies from a number of important banks, including the central banks of Japan, Canada, Singapore and the European Union.

The dominant concern for many banks was the potential for interoperability issues with legacy systems, citing this as the main reason for the slow rate of adoption. Interoperability has been a major cause for concern for most DLT solutions across industries. Banks are also concerned with security. As a result, they prefer ‘piecemeal adoption’, slowly over an extended period of time.

“Piecemeal adoption would be the preferable and most feasible option, according to respondents. Respondents highlighted the importance of rapid, thorough regulatory harmonization. Overall, respondents underscored that wholesale CBDC research and trials are still in their infancy, and that doubts remain over DLT’s ability to deliver on its promise” the report concludes.