Why it doesn't make sense for central banks to launch CBDCs

CBDCs are central bank digital currencies. For example, the US Fed could issue a US Cryptocurrency independent of the US dollar.

The US Federal Reserve has explored the potential benefits and risks of CBDCs from many angles, including technical research and experimentation. Their primary focus is whether and how a CBDC can enhance the secure and efficient US domestic payments system. So far, they have not made a decision.

The Bank of Canada and the Bank of England are also investigating CBDCs. France, Italy, Germany, and Japan also have CBDC projects underway. You have to wonder why the G7 didn't pool their resources and create a joint working group to investigate this rather than each duplicating the effort. Or at least the EU single currency participants.

The UK as a use case

As of 2021, the total value of Great Britain Pounds (GBP) in circulation was approximately ￡97.9 billion. Around 21% of the total value of GBP is in physical form, meaning about ￡20.6 billion worth of banknotes and coins were in circulation.

The remainder, ￡77.9 billion, is held as digital currency in people's banking accounts. It can be exchanged using payment cards or payment schemes like CHAPS, BACS, FP, and SWIFT. Most people don't know or care which scheme/network is used to move their money as long as payments are timely and error-free.

The current GBP digital currency has a regulatory framework and financial services companies that want to participate need to comply with regulatory and technical requirements to keep out proceeds of crime and protect customers from fraud and theft.

GBP can be exchanged for other currencies on countless digital and physical currency exchanges.

The Benefits of a Blockchain-based Digital Currency

Now we examine some potential benefits of blockchain cryptocurrencies. Proponents promote how it improves payments by providing:

• Decentralization
• Security
• Lower Fees
• Faster Transactions
• Greater Financial Freedom
• Accessibility

Decentralisation

One of the key features of blockchain technology is that it allows for decentralisation, which means that no central authority or intermediary controls the network. Hopefully, this can provide greater transparency and reduce the risk of fraud or corruption.

There are some downsides to decentralisation, too. A lack of standards and regulatory oversight has led to cryptocurrency fraud.

1.???BitConnect Ponzi Scheme: BitConnect was a cryptocurrency lending platform that promised high returns to its investors. However, it was later revealed to be a Ponzi scheme, and its operators defrauded investors of billions of dollars. In February 2021, one of the operators was arrested in India. Here's a link to a news article about the arrest: https://www.coindesk.com/ex-bitconnect-promoter-arrested-india

?2.???PlusToken Scam: PlusToken was a cryptocurrency wallet and investment platform that promised high returns to its users. However, it was later revealed to be a Ponzi scheme, and its operators defrauded users of billions of dollars worth of various cryptocurrencies. Several of the operators were arrested in 2020 and 2021. Here's a link to a news article about the arrests: https://www.reuters.com/article/crypto-currency-plustoken/plustoken-operators-who-allegedly-swindled-27-bln-arrested-chinese-police-idUSL4N2NT0BH

However, given its name, a central bank-issued cryptocurrency would likely need to cede control to a central bank authority. Any exchange trading in the currency would surely need to comply with government regulations to confirm currency owners' identity, prevent money laundering, enforce sanctions and prevent financial crime. I don't see how a central bank-issued digital currency can be fully decentralised in the sense that Bitcoin is decentralised.

Security

Cryptocurrencies use strong cryptographic techniques to secure transactions and protect user identities. Blockchain technology ensures that transactions are tamper-proof and that funds cannot be spent twice, providing a high level of security.

However, even though the currency itself might be secure, the exchanges holding them might not be.

1.???Poly Network Hack: In August 2021, Poly Network, a decentralised finance (DeFi) platform, was hacked for over $600 million worth of various cryptocurrencies. The hacker was eventually caught and returned the stolen funds. Here's a link to a news article about the incident: https://www.bbc.com/news/technology-58118767

2.???Mt. Gox Hack: Mt. Gox was one of the largest Bitcoin exchanges in the world until it filed for bankruptcy in 2014 following a hack that resulted in the loss of over 850,000 bitcoins, worth over $450 million at the time. Some of the bitcoins were later recovered, but many are still missing. Here's a link to a news article about the incident: https://www.bbc.com/news/technology-26228213

3.???DAO Hack: The DAO was a decentralised autonomous organisation built on the Ethereum blockchain that raised over $150 million in a crowdsale in 2016. However, it was later hacked, and the attacker was able to steal over $50 million worth of Ether. The incident led to a hard fork in the Ethereum blockchain, resulting in the creation of Ethereum (ETH) and Ethereum Classic (ETC). Here's a link to a news article about the incident: https://www.coindesk.com/the-dao-hacker-drained-3-5-million-in-a-new-attack-today

By comparison, the UK Faster Payments includes confirmation of recipient, a name-checking service for UK-based payments to reduce certain types of fraud and misdirected payments. Faster payments also use public key cryptography enables users to securely communicate on a public network and reliably verify the identity of a user via digital signatures. Due to the real-time nature of faster payments, they are irrevocable and cannot be cancelled.

So GBP is, in many ways, more secure than existing non-centralised cryptocurrencies. It is unclear how turning the pound into a blockchain-based cryptocurrency will improve its security if customers use the same high street banks and MasterCard/Visa card networks to move the CBDC around.

Lower fees

Traditional financial institutions often charge high transaction fees for transferring money, especially across borders. Cryptocurrencies can reduce these fees as they eliminate the need for intermediaries.

A quick look at Coinbase shows no fees for holding currencies and a convoluted calculation for transaction fees based on the selected payment method, the size of the order, jurisdictional location, and market conditions such as volatility and liquidity. Fees are listed in the trade preview screen before you submit your transaction and may differ for similar transactions.

Binance, another big cryptocurrency exchange, charges 0.10% to move money between currencies on their exchange and 4.5% for debit card purchases.

Let's look at the fees for a GBP account at Revolut and Neobank. There are no fees for adding money or monthly fees for holding money. Outbound payment transactions within the UK and EU are free. Also, transfers to other Revolut customers are free. International transactions in other currencies have fees of 0.3% to 2%. For reference, the 2% fee is for Uzbekistani Soms. In contrast, Swedish Krona and Australian dollars have a 0.3% fee (i.e., ￡3 for a ￡1,000 transaction).

For the average Brit, earning an income in pounds, paying rent in pounds, and buying groceries in pounds, a fee-free Revolut account looks like a clear winner. It's not clear how a cryptocurrency makes their life any better.

Faster transactions

Blockchain currency transactions can be completed almost instantly, regardless of where the parties involved are located. This is because no intermediaries do not need to verify and process transactions.

The UK Faster Payments scheme for moving GBP allows customers to initiate payment up to ￡1m online, using a mobile device, over the phone, or in a branch, 24 hours a day and seven days a week. The sender receives a confirmation within 15 seconds, and the money is usually available in the receiving customer's account almost immediately, although in rare exceptions, it can take up to two hours.

For international payments, Brits could set up an account with Wise. The payments will not necessarily be instant because the speed is constrained by the recipient country's payment infrastructure.

However, it's unclear how creating a blockchain-based pound will help achieve faster international payment transfers. There will still need to be a conversion to local currency and movement to a local account connected to local direct transfer or debit card networks. This introduces intermediaries.

Financial freedom

Cryptocurrencies can provide greater financial freedom by allowing people to store and transfer their wealth without needing a bank or other financial institution. This is supposed to be especially beneficial for people who do not have access to traditional financial services.

It's unclear to me how using a debit card or contactless mobile phone payment restricts people's freedom. Suppose you don't trust local financial institutions. There might be an issue in that case, but that isn't a big concern in the United Kingdom.

The top reasons people are underbanked:

1. Lack of trust or preference for alternative financial services: Some individuals may not trust or prefer traditional banks and instead opt for alternative financial services such as check cashers, payday lenders, or prepaid cards. According to a Financial Conduct Authority (FCA) report, 11% of adults in the UK were using alternative financial services in 2020. Given recent hacks and fraud at cryptocurrency exchanges, it is unclear how they will garner more trust than traditional banks or Neobanks.
2. Difficulty meeting minimum balance requirements: Some traditional bank accounts require a minimum balance to avoid monthly fees. This can be a barrier for low-income individuals. A report by the Financial Inclusion Commission found that around 1.5 million adults in the UK did not have a bank account due to high fees or a lack of money to maintain a minimum balance. While there is a perception that minimum balances are needed to open a traditional bank account, many banking service providers do not require minimum balances. This was addressed earlier when discussing transaction fees.
3. Lack of access to physical bank branches: Some individuals may not have access to a physical bank branch, either due to living in remote areas or due to the closure of bank branches in their area. According to a report by Which?, over 3,000 bank branches have closed across the UK since 2015. Most cryptocurrencies are not accessible via bank branches, and a government-sponsored cryptocurrency would likely be used in the same bank branches and ABMs available today, so adding a blockchain currency is very unlikely to improve access to physical branches.
4. Language barriers or unfamiliarity with banking practices: Immigrants or refugees may face language barriers or may be unfamiliar with the banking practices in the UK, making it difficult to access traditional banking services. A Centre for Social Justice report found that around 30% of households in some ethnic minority communities had no bank account. However, the languages used to serve customers are a business decision made by financial services providers. This is not solved by having a national cryptocurrency.
5. Mental health difficulties: Mental health issues can also contribute to underbanking or unbanking. According to a report by the National Disability Institute, individuals with mental health disabilities are more likely to be unbanked or underbanked compared to individuals without disabilities. Some people with disabilities often have difficulty with financial institution identification and authentication requirements such as identification cards, bank cards, PINs, and other personal identification questions used by institutions to prevent theft and account takeover fraud.

Sources:

"Financial Lives Survey 2020" (2021), Financial Conduct Authority

"Banking on Change: Breaking down barriers to financial inclusion" (2014), Financial Inclusion Commission

"Which? research reveals over 3,000 bank branches closed since 2015" (2020), Which?

"Financial Inclusion: A Door to Banking" (2016), Centre for Social Justice

"Understanding the financial capability and behaviours of the financially excluded" (2014), Money Advice Service

"Banking Status and Financial Behaviors of Adults with Disabilities" (2017), National Disability Institute

"Why People With Mental Health Issues May Not Use Banks" (2020), Forbes

"Mental Health and Financial Inclusion: Challenges and Opportunities" (2019), Financial Health Network

Accessibility

Cryptocurrencies are accessible to anyone with an internet connection, making them available to people worldwide. This provides greater financial inclusion and opportunities for people who do not have access to traditional financial services.

As of 2021, approximately 59.5% of the world's population has access to the internet, according to data from the World Bank. However, internet penetration rates vary significantly by region and country, with some areas of the world having much lower rates of internet access than others. For example, North America has an internet penetration rate of over 90%, while Africa has a penetration rate of only around 39%.

It's worth noting that internet penetration rates have been increasing rapidly in many parts of the world in recent years, with the number of internet users worldwide growing by over 300 million between 2019 and 2020 alone. However, there are still significant barriers to internet access for many people, including lack of infrastructure, cost, and other socioeconomic factors.

Sources:

"Individuals using the Internet (% of population)" (2021), World Bank

"Number of internet users worldwide from 2005 to 2022" (2022), Statista

"State of Broadband 2021" (2021), International Telecommunication Union (ITU)

It's important to note that there are also potential drawbacks and risks associated with cryptocurrencies, such as volatility, lack of regulation, and potential for illegal activities.

Conclusion

Non-blockchain digital currencies can provide equivalent security, speed, and transaction fees as blockchain-based digital currencies. As well, the pound provides more financial freedom than cryptocurrencies.

GBP is accessible via branch networks, the internet, mobile phone apps, and physical currency (e.g., bills and coins). So it is more accessible than cryptocurrencies.

Decentralised ownership and regulatory control is the key differentiator that blockchain technology brings to a currency, and that's the rub.

If we wanted a global multi-national currency that can not be influenced by any central bank, then decentralisation is necessary, but decentralisation is counterproductive in a currency issued and regulated by a central bank.

If the Bank of England wants to create a currency that it will not control, then institutions in the UK that operate in the new currency would still be subject to the Financial Conduct Authority (FCA).

As a society, we vote for a government that exerts central authority to protect consumers, prevent fraud, and protect our currency (savings and income) from volatility. This is all at odds with a decentralised blockchain-based CBDC.

We could switch the pound to blockchain ledgers. However, it would still be centralised and regulated and behave in much the same way it does today. So it would be a lot of effort for not much benefit.

Blockchain is an innovative and unique tool in our digital transformation toolbox, but it isn't a solution to every problem. We should always begin with the problem we are trying to solve and then search for the best tool(s) to solve them.

I'm not infallible and might be missing something here, so I welcome folks to DM me their opinions.