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This article first appeared in The Edge Malaysia Weekly on September 25, 2017 - October 1, 2017

BLOCKCHAIN-based cryptocurrency is often described as a solution looking for a problem to solve.

And any at-length discussion about the potential applications of the distributed ledger technology underlying all cryptocurrencies winds up at the door of central banks and fiat currencies.

In a twist of irony, could the very same gatekeepers that have kept cryptocurrencies out become their biggest adopters?

The Estonian government last month made the headlines when it proposed a state-managed cryptocurrency — estcoin.

The idea was shot down almost immediately by European Central Bank president Mario Draghi, saying, “No member state can introduce its own currency; the currency of the eurozone is the euro.”

While Estonia’s proposal was still highly conceptual at the time and not likely to get off the ground in the near future, it did raise some interesting questions — what would central bank cryptocurrencies (CBCCs) even look like, and how useful would they be?

On the home front, Bank Negara Malaysia has a cryptic (pardon the pun) view of cryptocurrencies in general. While it has indicated that guidelines are being drafted, the central bank declined to comment on cryptocurrencies as they were “still being studied”.

Nonetheless, discussions pertaining to cryptocurrencies and CBCCs are not new. Estonia’s audacious proposal is far from the first time the idea was broached. Fedcoin, a theoretical cryptocurrency created and managed by the US Federal Reserve, has been circulating in academic discussions since 2014.

The idea is relatively simple on paper. Only the Fed would be able to create Fedcoins and they can be converted into cash or reserves one for one. Fedcoins would be created (or destroyed) only if an equivalent amount of cash or reserves were conversely destroyed (or created) at the same time. Just like cash, the hypothetical Fedcoin would be decentralised in transaction and centralised in supply.

Such a CBCC would have virtually none of the volatility that has come to define bitcoin.

Last week, the Bank of International Settlements (BIS) published a report that examined the case for CBCC and summarised the complicated topic such: “We argue that the main benefit that a consumer-facing retail CBCC would offer, over the provision of public access to (centralised) central bank accounts, is that the former would have the potential to provide the anonymity of cash.

“In particular, peer-to-peer transfer allows anonymity vis-à-vis any third party. If third-party anonymity is not of sufficient importance to the public, then many of the alleged benefits of retail CBCCs can be achieved by giving broad access to accounts at the central bank.”

In a nutshell, the key benefit BIS found in the decentralised nature of CBCC was the promise of third-party anonymity — only you and the counter-party you are transacting with will know.

But therein lies the paradox for a central bank considering a centrally supervised CBCC, as highlighted in an Alphaville article in the Financial Times. It can be summarised in one question: Is providing anonymity the objective of issuing a CBCC?

It is difficult to imagine any central bank answering yes to this question, given the years of policy focused on ensuring that cash flow is easily traced so that it does not stem from illegal activity.

If the answer is no, then there are other options at the disposal of central banks. Options that are more familiar to work with as well — a conventional digital currency that is managed by the central bank as opposed to digital currencies managed by commercial banks.

“As it stands, cash is the only means by which the public can hold central bank money. If someone wishes to digitise that holding, he/she has to convert central bank liability into a commercial bank liability by depositing the cash in a bank,” notes the BIS report.

A CBCC would allow consumers to hold central bank liabilities in digital form but this can also be achieved if the public were allowed to have central bank accounts — an idea that has been around for a long time.

The various forms of currency can be demonstrated in the “money flower” .

However, there would be huge drawbacks from a privacy perspective. In a country where all public currency is held in digital form in central bank accounts, all transactions would be under the purview of regulators. When, how and with whom transactions take place can be traced with impunity.

Beyond the potentially Orwellian implications of such state scrutiny, there are also other practical implications. Commercial banks, for example, might become disintermediated and hence, less able to perform essential economic functions, such as monitoring borrowers, notes the BIS report.

On the other side of the coin, it is important to remember a trait of physical cash that has made it especially cherished by those who use it for illicit purposes — cash is difficult, nay impossible, to track.

Fortunately, cash is also kept in check by its physical nature. Large amounts are difficult and costly to move around and oftentimes problematic to transact. A sports car or a small flat might be paid for in cash, but not much more.

A CBCC with complete anonymity would allow these negative traits of cash to be exploited on a whole new scale — the exact reason bitcoin and other alternative coins have central banks on the edge of their seat.

That said, Malaysia is still a predominately cash-based society. It is likely that we will get to observe how other central banks experiment with CBCCs first. Perhaps somewhere like Sweden where physical cash is quickly becoming a novelty.

 

 

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