Casey Wagner

Central bank digital currencies could potentially allow for more efficient payments down the line.



But a new report from RBC Wealth Management says the risks to privacy and security outweigh any reward.&nbsp;



As more governments begin exploring CBDCs — the Bank for International Settlements says 93% of central banks are pursuing such efforts — analysts and economists have raised questions about the costs of some of these theoretical benefits.&nbsp;



The US, in particular, needs to be especially cautious when developing a CBDC, given the dollar’s status as the global reserve currency, according to RBC analyst Atul Bhatia.



“We think having a single point of failure for dollar payments in a world that uses the greenback for all manner of trade is, in a nutshell, a terrible idea,” Bhatia wrote in a <a href="https://www.rbcwealthmanagement.com/en-ca/insights/central-bank-digital-currency-and-the-future-of-money">report</a> published this week. “In one move, we think the US would create an unparalleled target for hackers and thieves, not to mention terrorists or geopolitical rivals.”&nbsp;



Bhatia added that a centralized, government-controlled point of financial information raises privacy concerns as well as security ones.



“In the US, federal officials already have broad access to individual financial data via subpoena powers, but combining all financial information in one spot is a step-change higher in potential informational abuses,” Bhatia said.&nbsp;



<a href="https://blockworks.co/tag/cbdc">CBDC</a> proponents argue that criticisms over theoretical CBDC models and structures are unfounded because the project is, in the US at least, just that: theoretical.&nbsp;



“A [US] CBDC does not exist yet, so how are you saying that [the surveillance is invasive],” Mark Young, chief risk officer and data adviser at ConsenSys, said at the Milken Institute Future of Digital Assets Symposium earlier this year. “The onus is on us to design what we want and to design something that demonstrates democracy.”&nbsp;



As other countries push ahead with their pilot programs and launches, such as the Bahamas and China, American regulators possess an opportunity to learn from other efforts and create better models.&nbsp;



Read more: <a href="https://blockworks.co/news/russia-digital-ruble-putin">Russia to commence digital ruble pilot testing with 13 banks</a>



“I think because of that, as we’re seeing each country develop from a technical standpoint, each of their CBDCs, understanding how to build privacy into the different layers, or not, is really important because I think that is what will give them a competitive edge,” Jennifer Lassiter, executive director of the Digital Dollar Project, said at the Milken event.&nbsp;



Plus, certain tech innovations could help enhance privacy, the Digital Dollar Project noted in a June 2023 <a href="https://digitaldollarproject.org/wp-content/uploads/2023/06/Risk-Working-Paper_Secure-adoption-of-a-digital-dollar.pdf">report</a>. Researchers suggest that the <a href="https://blockworks.co/tag/federal-reserve">Federal Reserve</a> and other agencies could use mixing services or tumblers to create a more private experience.&nbsp;



“These advantages should be weighed against potential compliance and law enforcement trade-offs, such as the ability of tumblers and mixers to prevent the network from preserving funds provenance when necessary for critical bank practices like sanctions investigations,” the Digital Dollar Project report added. 



In terms of what to expect in the US, Bhatia predicts the Fed will opt for an “incremental” approach, noting that the central bank will prioritize limiting risks to the payments infrastructure.



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CBDC

CBDC risks outweigh rewards, experts say

Jocelyn Yang

<div id="highlights-block_62b0ea456e0f3" class="highlights">
 <ul>
 <li>The institution said the future monetary system should be built on the trusted division of roles between the central bank and private sector entities</li>
 <li>In another bulletin issued in June, BIS economists said “decentralization proves to be an illusion”</li>
 </ul>
 
</div>



As <a href="https://cms.blockworks.co/how-cryptoasset-markets-have-changed-since-terra-crash/" target="_blank" rel="noreferrer noopener">Terra’s stablecoin implosion</a> and recent <a href="https://cms.blockworks.co/crypto-total-market-capitalization-under-1t-after-10-fall/" target="_blank" rel="noreferrer noopener">market turmoil</a> have demonstrated crypto&#8217;s volatility, central bank digital currencies, or CBDCs, offer a more stable solution for a future monetary system, according to the Bank of International Settlements (BIS).&nbsp;



Crypto’s security risks, high fees and scalability issues, as well as its “unregulated intermediaries that pose financial risks,” are growing concerns in today’s monetary system, BIS said in its annual report, released Tuesday.



“The crypto universe lacks a nominal anchor, which it tries to import, imperfectly, through stablecoins,” the report said. “​​These structural shortcomings are unlikely to be amenable to technical fixes alone. This is because they reflect the inherent limitations of a [decentralized] system built on permissionless blockchains.”&nbsp;



“The crypto sector provides a glimpse of promising technological possibilities, but it cannot [fulfill] all the high-level goals of a digital monetary system,” it added.&nbsp;



BIS argues that a future monetary system should contain both the “retail CBDC level” — which is predominantly used by individuals to pay each other or businesses — and “the wholesale CBDC level” — which is used by financial institutions to settle trades in markets.



The monetary system should be built on the division of roles between the central bank and private sector entities, the institution said in its report.



“The metaphor for the future monetary system is that of a tree, whose solid trunk is the central bank,” Hyun Song Shin, BIS’ economic adviser and head of research, said in a statement. “This tree boasts a rich and vibrant ecosystem of private sector service providers serving users to [fulfill] their economic needs. The ecosystem is rooted, figuratively speaking, in settlement on the central bank’s balance sheet.”&nbsp;



Earlier this month, Israel&#8217;s central bank announced a partnership with the Hong Kong Monetary Authority and BIS’ Innovation Hub to test the feasibility of a retail CBDC, <a href="https://www.reuters.com/markets/currencies/bank-israel-bis-hong-kong-cenbank-test-retail-cbdc-feasibility-2022-06-16/" target="_blank" rel="noreferrer noopener">Reuters</a> reported.&nbsp;



China <a href="https://cms.blockworks.co/china-debuts-digital-yuan-at-winter-olympics-amid-warnings-from-us-senator/" target="_blank" rel="noreferrer noopener">rolled out</a> the pilot for its own CBDC, or eCNY, at the Beijing Winter Olympics in February this year, and Jamaica’s Jam-Dex earlier this month became the world’s first CBDC to be recognized as <a href="https://cms.blockworks.co/in-historic-move-jamaica-makes-cbdc-akin-to-cash/" target="_blank" rel="noreferrer noopener">legal tender</a> — it will officially launch for public use later this month. Several countries, including <a href="https://cms.blockworks.co/kenya-seeks-public-opinion-on-potential-cbdc/" target="_blank" rel="noreferrer noopener">Kenya</a>, Brazil and Haiti, are also <a href="https://cms.blockworks.co/why-emerging-markets-are-leading-the-charge-on-cbdcs/" target="_blank" rel="noreferrer noopener">exploring</a> the technology.



“This architecture is assumed to have several benefits: less financial risk for the customer, more liquidity, lower costs, increased competition, and wider access,” the Bank of Israel said.



The BIS said retail CBDCs could play a similarly beneficial role in developing fast payment systems, citing the technical feasibility of a CBDC architecture — also known as <a href="https://news.mit.edu/2022/digital-currency-fed-boston-0203" target="_blank" rel="noreferrer noopener">Project Hamilton</a> — that can process 1.7 million transactions per second, which is “far more than major card networks or blockchains,” according to the report.&nbsp;



“These new capabilities not only permit the expansion of the types of transactions, but also enable transactions between a much wider range of financial intermediaries — not just commercial banks. Wholesale CBDCs also work together across borders, through multi-CBDC arrangements involving multiple central banks and currencies,” the report said.&nbsp;



In another bulletin issued in June, BIS economists said “decentralization proves to be an illusion” and <a href="https://cms.blockworks.co/decentralization-proves-to-be-an-illusion-bis-says/" target="_blank" rel="noreferrer noopener">suggested</a> decentralized lending systems would “gravitate towards greater centralization.”



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CBDCs the Core of Future Monetary System: BIS Report

<div id="highlights-block_624de6f47b4f6" class="highlights">
 <ul>
 <li>Fed officials plan on pulling back economic support at a faster rate than expected</li>
 <li>Cryptocurrencies fell on the news while stocks traded sideways</li>
 </ul>
 
</div>



Federal Reserve officials are planning on reducing the central bank’s trillions of dollars in bond holdings by around $95 billion a month, minutes from the March meeting show.&nbsp;



Central bankers also plan to allow some of their government-backed holdings to expire, helping to pare down the Fed’s balance sheet, which currently stands at $9 trillion. A limit of $60 billion in Treasurys and $35 billion in mortgage-backed securities would be allowed to roll off, officials “generally agreed,” the <a href="https://www.federalreserve.gov/monetarypolicy/files/fomcminutes20220316.pdf">minutes</a> note.



The Fed voted to raise rates a quarter of a percentage point in <a href="https://cms.blockworks.co/fed-raises-interest-rates-a-quarter-percentage-point/" target="_blank" rel="noreferrer noopener">March</a> and officials noted that an increase in the pace of interest rate hikes may come in the near future. 



St. Louis&nbsp; ​​Fed President James Bullard was the only official to vote against the action, “preferring to raise the target range for the federal funds rate by 0.5 percentage point to ½ to ¾ percent in light of elevated inflation pressures,” according to the minutes.



“The Fed cannot afford, literally and figuratively, to bail out the economy from the forthcoming recession,” David Tawil, president of crypto hedge fund firm ProChain Capital. “Rates must go higher, otherwise we will have a decade of stagflation.”



The minutes come as the central bank begins to tighten monetary policy with inflation rising at the fastest pace in four decades. Russia’s invasion of Ukraine has also presented additional economic challenges, the minutes note. Commodity prices have been pushed higher, “hurting global risk sentiment, and exacerbating supply bottlenecks,” the minutes read.



Cryptocurrencies largely fell on the news, with bitcoin and ether losing about 4% and 7%, respectively. Stocks traded sideways with the S&amp;P 500 losing close to 1% and the Dow Jones down 0.5%. The tech-heavy Nasdaq was trading almost 1% higher.&nbsp;



“We were having a bad day before the announcement, and it got worse,” Tawil said. “Today, crypto is trading like a technology company equity.”



Others are less certain, though, that the Fed’s current policy path will push crypto lower.



“I don&#8217;t think history supports the view that reduction of the Fed&#8217;s balance sheet is necessarily bad for crypto,” said Jack Farley, macro analyst and host of Blockworks&#8217; <a href="https://cms.blockworks.co/podcasts/forwardguidance/" target="_blank" rel="noreferrer noopener">Forward Guidance</a> podcast. “The last (and only) instance of quantitative tightening by the Fed began in October 2017, and bitcoin went up 340% from then until its peak in December 2017.”



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