The ECB is looking at how a CBDC can ensure that central banks maintain monetary sovereignty around the world, without being overwhelmed by private cryptocurrencies.
The European Central Bank released a discussion paper this week on the pros, cons and economics of central bank digital currency (CBDC) implementations. It suggests that CBDCs could help prevent the dominance of BigTech companies in the payments market due to “network externalities” around the use of the medium of exchange.
Ultimately, the article argues that CBDCs may be “the only solution to ensure the continued smoothness of the current monetary system.”
Threats of digital platforms
The panel discussion began by noting the growing interest in CBDCs, which are currently being explored by central banks around the world. So far, they have been launched in two countries: the Bahamas (Sand Dollar) and in Nigeria (eNaira).
The report identifies the growth landscape and their potential adoption in the context of the larger phenomenon of a rapidly digitizing economy and world. This has led to digital platforms becoming the dominant business model and the growing role of data and software. However, it also contributes to an anti-competitive environment that is centralizing digital market power with a handful of tech giants.
This centralization trend is due to “network externalities” – meaning that users are attracted to these platforms precisely because others are using them.
“On the extreme side, this can lead to winners,” the report explains.
Regarding cryptocurrencies, the ECB is concerned that the dominant platforms issuing digital currency (e.g. Diem) could use network externalities to become the dominant private issuer of coins. This could hypothetically challenge the monetary sovereignty of the domestic economy – its supremacy over the economy’s currency serving as a store of value, medium of exchange and account unit.
What a CBDC Can Offer
As a remedy, the report proposes CBDC as a tool that can ensure continued use of public money in the economy. It can reduce settlement costs, resolve conflicts in financial intermediation, and improve the central bank’s ability to serve as a lender of last resort.
By safeguarding monetary sovereignty, CBDCs will help maintain central bank control over monetary policy. If prices in the economy are priced in another currency, then any expansionary policy will only create a bout of inflation without increasing economic output.
“In theory, the monetary authority could ‘print’ an unlimited amount of local currency to support troubled financial institutions,” the report explains. “However, such liquidity support is no longer available if the liabilities are denominated in foreign currencies, which increases the operational risk of the bank (even for solvent institutions).”
Facebook’s project to launch Diem – a global dollarized country crypto project – finally failed after much resistance to regulations and politics. Countries like France and Germany confirmed early on that they would block the project as it has the potential to undermine traditional financial institutions.
Since its collapse, Diem’s former project manager David Marcus has turned to work on Bitcoin. Major cryptocurrency loyalists, like Jack Dorsey, believe that it alone can challenge the dollar’s global supremacy.
However, central bankers are not overly concerned with this particular asset. Former Federal Reserve Chairman Ben Bernanke stated in May that Bitcoin has failed as an alternative currency. Later that month, the Central Bank of Sweden clarified its position that Bitcoin and Ethereum are not classified as currencies, mainly due to their volatility.