Bitcoin. Stablecoin. CBDC. Who Changed My Money?
What effect CBDCs will have on the monetary system is a key question facing central banks, says Neha Narula of MIT Media Lab.
What is money to you?
The cash in your wallet? The balance in your bank account? The credit limit on your card?
As Neha Narula, now director of the digital currency initiative at MIT Media Lab, put it in a TED talk a few years ago, money, at its most basic, is anything that communities and societies attach collective value to.
For most of our lifetimes, money has been fiat currency—backed by governments and the value they attach to it. Then came Bitcoin, Ether, Dodgecoin and many more such ‘cryptocurrencies’. While boom and bust cycles in cryptocurrencies, which have been around for over a decade now, have come and gone, the pandemic brought on another bout of belief in these units. That belief reflected in the 672% rise in the price of Bitcoin since the start of 2020. It now trades at over $55,000.
Cryptocurrencies are increasingly being seen as a store of value, Narula said in a conversation with BloombergQuint. “We have really seen a lot more use cases develop for what cryptocurrency can do and we’ve seen it embraced at almost the highest levels,” said Narula, adding that data on the precise manner in which cryptocurrencies are being used is still thin.
I think that by far the most dominant use case for cryptocurrencies, like Bitcoin, is as a store of value. So people are investing in Bitcoin, the way that they might invest in gold, for example ... We’re starting to see, in the U.S. for example, very large companies and investors like Elon Musk, Mass Mutual, Square, putting a significant amount of their treasury [funds] in Bitcoin.Neha Narula, Director - Digital Currency Initiative, MIT Media Lab
The past year has also seen a number of mainstream payments firms trying to capture interest in cryptocurrencies.
In October 2020, Paypal said it would allow U.S. users to 'buy', 'sell' and 'hold' cryptocurrencies. In February 2021, Mastercard said it would start supporting select cryptocurrencies on its network this year. The same month, Visa said it would roll out cryptocurrency buying and trading services over the course of the year.
So, are cryptocurrencies money now?
Not yet, says Narula. They are still hard to use and non-intuitive. Besides, they are too volatile. “It’s not a great thing if the sandwich you buy costs two times the amount that you paid for it the previous day, which could very easily happen if you were making that transaction in something like Bitcoin.”
Central Banks See Red
Where there is a problem, there is a solution. The solution to the inherent volatility in cryptocurrencies emerged via, as the name suggests, stablecoins. These are cryptocurrencies, whose value is pegged to something far more stable, like the U.S. dollar or a basket of currencies or traded commodities. Facebook-promoted Libra, now relabeled ‘Diem’, is an attempt at a stablecoin.
This made central banks see red.
The prospect of a stablecoin, backed by a large network like Facebook with over two billion users, had the potential to impinge on monetary sovereignty.
In a report last year, the Bank of International Settlements flagged this risk.
“A risk of stablecoins, so-called “cryptocurrencies” and foreign CBDCs is that domestic users adopt them in significant numbers and use of the domestic sovereign currency dwindles. In extremis, such a “digital dollarisation” could see a national currency substituted by another with the domestic central bank gradually losing control over monetary matters,” the BIS said.
Governments and central banks could imagine something like Libra-isation, where a currency could get adopted on a mass scale and affect the ability of a country to regulate its economy and financial system, Narula said.
This led to a speeding up of work on ‘central bank digital currencies’. Cryptocurrencies may still continue to be seen as a store of value, but those looking at digital currencies as a way to make transactions faster and cheaper may see merit in CBDCs, Narula said.
CBDC really has a role in modernising our payment system and providing a new platform for innovation. So, in that respect, I think there is a role for CBDCs. People who are interested in holding value that is not tied to a government will continue to use cryptocurrencies.Neha Narula, Director - Digital Currency Initiative, MIT Media Lab
CBDCs: What, Why, How...
Nearly 86% of central banks surveyed by the BIS earlier this year said they are studying CBDCs, although only 14% are moving towards development. The Bahamas ‘Sand Dollar’ is the only operational CBDC and China’s pilot programmes conducted last year as by far the largest.
But the ‘what, why, how’ still need to be answered before CBDCs become commonplace.
The ‘what’ is the simplest to answer. A CBDC will be a direct claim on the central bank and not a liability of a financial institution. It will be denominated in the national currency unit. It will be the digital currency equivalent of cash.
But why do we need it? We can already make payments digitally via online transfers, cards and, in the case of India, via UPI?
This is where answers become less clear. Some smaller countries like the Bahamas are seeing it as a way to improve financial inclusion. Others, like China, are trying to regain control over payments that had moved to private networks in large volumes. In countries where cash is still dominant, a CBDC may prompt a quicker shift. In others, where digital payments have picked up in other ways, the utility of a CBDC is less clear.
India, for instance, might not need a CBDC given the success of UPI, said Narula. “However, it’s unclear that we can replicate exactly what India did in other countries ... Many other countries don't have a digital identity system that is supported by the government and so a different model is going to need to emerge.”
Even if the ‘why’ is answered in the affirmative, the ‘how’ remains. This is where central banks are grappling with the toughest questions. Will a CBDC offer interest? If it does, will it disrupt traditional banks? Is there a limit on how much CBDC a citizen can hold? What about international transfers?
I think one of the most important questions is what type of effect a CBDC will have on the monetary system in a country and globally. A lot of that depends not just on the policies around the CBDC but also how they are implemented and how they actually work. So, in some sense, we have to design the technology and consider the policy in tandem and that’s what makes it so challenging. You can’t just go off and decide that I want my CBDC to have properties X Y and Z. You also have to think about what the technology can even support and how people might use your CBDC in ways that you didn’t expect.Neha Narula, Director - Digital Currency Initiative, MIT Media Lab
And then there’s privacy.
Cash, beyond the point of withdrawal, can’t be easily tracked. Digital transactions, by their very nature, can.
People, the world over, are beginning to worry about having all of their information and personal data collected either within a company or by governments, Narula said.
“It can be very difficult to actually protect that data effectively. We've seen hacks here in the U.S. recently where a lot of data has been leaked... However, when we start to think about privacy, then we must consider the question of compliance. How do we prevent illicit activity on the platform? We can't just have everything be private completely. So, I think this is going to be a really important concern in the coming years.”
Watch the full conversation with Neha Narula, Head - Digital Currency Initiative, MIT Media Lab, below: