This year, bitcoin has mesmerised many investors. Never mind the fact that it has doubled in price, after tripling in 2020; nor that figures such as Elon Musk have backed it this week he tweeted that Tesla cars will be sold in bitcoin. What is even more remarkable is that some establishment players such as Citigroup now think bitcoin "may be optimally positioned to become the preferred global currency for trade" in the future, a role currently occupied by the dollar. But while this is headline-grabbing, there is a second crypto tale unfolding that most people have noticed less: central bank experiments.

 This week the Bank for International Settlements held an "innovation" conference, at which Jay Powell, Federal Reserve chair, explained that Fed officials are working with the Massachusetts Institute of Technology to explore the feasibility of a dollar-based central bank digital currency. Details are sparse. But a CBDC essentially enables consumers to use computerised code as "money", thus echoing some of the features of bitcoin, or the type of crypto coin being developed by Facebook. 

But this computer code would be created and controlled by the Fed  not Facebook or faceless bitcoin "miners". Powell stressed this digital dollar would not emerge quickly, if at all, saying "there is no need to rush". But the symbolism is striking, since it reflects a subtle but notable shift in attitude among regulators. When bitcoin and other fintech innovations first emerged this century, many central bankers either dismissed or derided them in conversations with me. They remain so: Powell suggested this week that bitcoin was primarily a speculative investment substitute for gold, not for the dollar; Agustín Carstens, BIS head, warned it was mostly used for regulatory arbitrage. But what central bankers are belatedly realising is that the reason such innovations have emerged is that entrepreneurs are responding to two big flaws in modern finance. 

One revolves around something that central bankers seem unwilling or unable to address: the risk that fiat currency is debased in the future by excessive supply, ie quantitative easing. The other is something central bankers do want to address: the clunky nature of the modern payments system. As Powell recently observed: "The Covid crisis has brought into even sharper focus the need to address the limitations of our current arrangements for cross-border payments." Thus, what the Fed and others are now trying to do is a mild version of the "if you can't beat 'em, join 'em" strategy: instead of ignoring bitcoin or Facebook's experiments, they hope instead to harness some of the ideas behind such innovations as blockchain ledgers on their own terms. Or, if you like, out-crypto the crypto kids. Will it work? There are reasons to be sceptical. One problem is style: asking stodgy central bankers to embrace the type of freewheeling creativity found in fintech is like asking grandpa to listen to rap. Another, even more daunting, issue is that CBDCs create huge policy headaches, such as the future role of private sector banks.

But what central bankers are belatedly realising is that the reason such innovations have emerged is that entrepreneurs are responding to two big flaws in modern finance. One revolves around something that central bankers seem unwilling or unable to address: the risk that fiat currency is debased in the future by excessive supply, ie quantitative easing. The other is something central bankers do want to address: the clunky nature of the modern payments system. As Powell recently observed: "The Covid crisis has brought into even sharper focus the need to address the limitations of our current arrangements for cross-border payments." Thus, what the Fed and others are now trying to do is a mild version of the "if you can't beat 'em, join 'em" strategy: instead of ignoring bitcoin or Facebook's experiments, they hope instead to harness some of the ideas behind such innovations as blockchain ledgers on their own terms. Or, if you like, out-crypto the crypto kids. Will it work? 

There are reasons to be sceptical. One problem is style: asking stodgy central bankers to embrace the type of freewheeling creativity found in fintech is like asking grandpa to listen to rap. Another, even more daunting, issue is that CBDCs create huge policy headaches, such as the future role of private sector banks.

Based on the information answer the question:

What are the risks for commercial banks associated with the potential introduction of CBCDs? 

Answer rating: 100% (QA)

The potential introduction of Central Bank Digital Currencies CBDCs poses several risks for commercial banks 1 Disintermediation CBDCs have the potent... View the full answer