Goldman Sachs’ econ research division, headed by Jan Hatzius, has a status report out this week on central bank digital currencies, and it inadvertently homes in on two factors that are increasingly becoming understood as essential in CBDC structures worldwide.
The first pertains to anonymity; the second, to how balances might be treated or capped to avoid the interest arbitrage that bleeds funding from the conventional banking system.
As the report notes:
Central banks have been cautious to avoid two key risks that CBDCs could pose. To avoid disintermediating banks by depriving them of their deposit base, central banks have imposed caps on balances, paid no interest on CBDC, or considered imposing a penalty interest rate on holdings above some threshold. To avoid facilitating illicit activity, central banks have mostly decided against fully anonymous accounts or capped anonymous transactions, and have tasked commercial bank intermediaries with monitoring customers and transactions.
While none of that may sound controversial upon first reading, it’s worth considering the wider picture.
What CBDC research and experimentation appears to be showing is that it will be nigh on impossible to issue such currencies outside of a comprehensive national digital ID management system. Meaning: CBDCs will likely be tied to personal accounts that include personal data, credit history and other forms of relevant information.
There are a number of reasons for this, but the most important one relates to the longstanding argument that without CBDCs cash would cease to function as a public good in the digital era. The rationale further dictates that if western central banks don’t come to market with cost-effective digital cash substitutes, private sector competitors will issue them within walled-garden structures instead. This would be bad, the theory goes, because it might endow private entities with the ability to extract oversized rents from the system or to disenfranchise many vulnerable segments of society.
One need only look at conventional digital payment services, and the prevailing financial exclusion problem, to understand how much worse it might get if instead of many banks competing against each other (and excluding people one by one over time but never universally), a single private-sector provider with a monopolistic footprint were to dominate.
But to solve this problem CBDCs would have to be structurally designed to be universal and accessible to everyone, regardless of their credit history or record.
And herein lies the challenge for central banks, which are also supposed to be subscribed to FATF standards on anti-money laundering and know-your-customer regulations.
If the system is universal and cannot discriminate, it cannot also prevent the facilitation of illicit activity. Exclusion or blacklisting in such is a system is simply not an option. And that means other mechanics would have to come into play to solve the moral hazard inherent in such a set-up.
Which brings us to problem two. If CBDCs are to be universal and available to anyone, they are likely to have an unfair advantage in terms of funding over the conventional banking sector. And that, as we have often written about, risks turning central banks into state-banking type institutions.
Regarding the disintermediation risk Goldman notes:
. . . central banks have designed their CBDCs to not pay interest or are considering setting a penalty on holdings above a certain threshold. Some central banks have also imposed caps on total balances or allowed commercial bank intermediaries to limit the degree to which customers can exchange existing deposits for CBDC.
As for the illicit finance risk:
To address this, central banks have mostly decided against fully anonymous accounts or have capped the size of anonymous transactions. Governments have varying degrees of insight into transactions and have generally put the burden of monitoring CBDC customers and transactions on commercial bank intermediaries.
As the following table summarises, this is why most central banks are designing their CBDCs to be account-based or ID-verified.
But if money is to be identity-based rather than token-based and fungible, this introduces a whole new set of ethical dilemmas and social questions, which aren’t really being asked at the moment on a wide enough social level.
The conversations we should be having relate to who do we as a society really entrust with our personal data? The current choice includes private companies like Facebook, highly regulated private institutions like banks, “independent” central banks, government-directed central banks, a bit of everyone or nobody at all.
When money goes ID-based, one also has to consider the broader parameters of the potential data creep. Just how far should that personal file reach? What sort of non-monetary information should or shouldn’t be contained within it? To what degree should account-holders be able to refuse access to their data to third parties? Who might the government entrust to manage and operate these schemes, and how can we hold them to account?
In many CBDC iterations, as Goldman Sachs notes, it’s the broader banking system that is expected to manage the related identity systems and customer-facing relations. But if that’s the case, what’s in it for the banks? How are they likely to be remunerated for offering these at-cost if not loss-making services?
In the end one size is unlikely to fit all, not least because what works for authoritarian countries like China, which have both the inclination and the power to impose intensive surveillance-based money systems on their people, is unlikely to suit longstanding democracies like Britain, which famously have an aversion to national identity document schemes.
One indicator of democratic will for such schemes comes in the shape of the outcome of the recent Swiss referendum on the introduction of a potential national electronic identity system. The final results saw 64.4 per cent of voters coming out against the scheme. Interestingly, however, opposition to the proposal was centred not on rejection of an eID system outright but on the idea that it should be provided entirely by the government under full democratic oversight and not by private companies as originally envisioned.
However CBDCs evolve over the long run, what this tells us is that it is of paramount importance that politicians and central bankers engage the public in the development of ID-based money systems more broadly. As it stands, the state of the discussion is so specialised and technical, new monetary systems risk being swept in without any democratic oversight at all.