The race is on at major central banks to develop state-backed digital money, known as GovCoins or CBDCs (central bank digital currencies). We look at the risks and benefits of the next stage in the financial revolution that's affecting how we hold, transfer, and use money.
Inside the European Central Bank's gleaming glass-and-steel skyscraper at Sonnemann Strasse in Frankfurt, experts are wiring together a fully electronic euro. And even behind the historic, granite-grey façade of the Bank of England in London's Threadneedle Street, similar plans are in hand for a high-tech new form of the pound. When announced at a February 2023 press conference, Fleet Street reporters christened it "Britcoin" (much to the unease of the Bank – but more about that later).
Like many of the world's monetary guardians, the Bank of England's Governor Andrew Bailey is keen to ensure that currency as we know it – issued and backed by national governments or international blocs – remains in place even as digital payment becomes the main means of exchange.
"A digital pound would provide a new way to pay, help businesses, maintain trust in money, and better protect financial stability," he said, as he launched a consultation process in February 2023 on what he called "a profound decision … on the way we use money."
The explosion in the use of payment apps and digital coins has opened the way for money born in the digital word, like Bitcoin, to compete with established forms of cash. These cryptocurrencies are threatening to break the monopoly of governments on issuing the means of exchange, unchallenged until the internet age. The International Monetary Fund recently revealed plans for a platform for global central bank digital currencies, or CBDCs.
Central banks don't recognize cryptocurrency as proper money, pointing to its highly speculative nature and enormous volatility, which is why the Bank of England rejected the name "Britcoin" for its digital pound. But the same kind of technology used to control crypto's authenticity, like Bitcoin's Blockchain, could also work for more stable, state-backed alternatives.
This is why the development of GovCoins, or CBDCs, is opening up new frontiers for the traditional powerhouses of international finance – while simultaneously introducing a complex set of risks and implications, and some potential breakthroughs, as this once-fringe technology goes mainstream.
Foremost among the issues is what an e-euro or digital pound would mean for private sector financial institutions. High street banks and savings-and-loan companies currently sit between regular account holders and the central banks. What happens to this centuries-old, multi-billion dollar business model when GovCoins act like a deposit made directly into state-owned vaults deep under the streets of the world's financial capitals?
CBDCs will have to work like cash to be useful for digital payments, and run on accessible and widely accepted apps and platforms. Since GovCoins are state-backed, by definition, they'll provide an easy means of exchange that eliminates the main danger posed by private-sector account providers and payment tech: insolvency of the backer. After all, central banks can generate cash at a keystroke, so they're uniquely safe.
This lack of 'counterparty risk' for GovCoins is uppermost in the minds of central bankers as they set out plans that will bring them into direct contact with the public. It's an unavoidable consequence of keeping official, state-issued money at the heart of an electronic system currently dominated by private-sector platforms like Apple Pay, PayPal and AliPay, even if central banks avoid issuing current accounts, as is expected.
What about the danger of CBDCs and their apps wiping out their non-government predecessors? There are various ways that public- and private-sector payment systems could co-exist. From caps on the value of deposits in CBDCs, to matching schemes designed to ensure some state-issued digital money is held by regular banks, the details will emerge over time.
One important difference is likely to be that deposits in GovCoins – wherever and however they are held – will not pay interest. That, plus size limits on transfer-only accounts, means traditional bank accounts should not face an existential threat from CBDCs, or bank runs from private to central banks.
China is already running trials of an e-yuan. The Bahamas, long keen on promoting digitized money despite bearing the scars of hosting the collapsed cryptocurrency exchange FTX, already offers a state-backed "sand dollar". This fully digital, government-backed version of the Bahamian dollar is pegged to the US dollar, and can be transferred via mobile phone free of transaction costs.
The US Federal Reserve is keeping watch. With the US dollar still unchallenged as the world's main reserve currency, Fed Chairman Jerome Powell told a recent panel at the International Monetary Fund, "We do think it's more important to get it right than to be first, and getting it right means that we not only look at the potential benefits of a CBDC, but also the potential risks, and also recognize the important trade-offs that have to be thought through carefully."
Such words have stoked concern in political circles, particularly in Washington, where the prospect of China taking the lead in the development of GovCoins causes unease. Elsewhere, the possibility of an international financial system less reliant on the dollar is welcome, even if digitized currencies also raise worries about civil liberties and governments' abilities to track citizens' spending.
Whatever the medium- and long-term implications of the rise of CBDCs, numerous questions need answering, including their potential impact on exchange rates, and how the standardized transaction data needed for international use would work. Solving these issues will take time and effort. And not every major central banker backs GovCoins. Thomas Moser, a member of the governing council of the Swiss National Bank, told the CNBC TV network that he doesn't see the need for CBDCs.
Nonetheless, their potential benefits are significant, not least because GovCoins offer a path into the banking system for people currently too risky for traditional private sector banks to serve. They also reduce the risk of relying on private payment platforms at a time when established cash is in long-term decline. Furthermore, GovCoins would make it harder to use private-sector cryptocurrency to avoid sanctions and taxes, by undermining the case for non-CBDCs.
In fact, GovCoins could arrive more quickly than you'd think. Somewhere in the ECB's 45-story HQ, work has progressed so fast that its President, Christine Lagarde, said a digital euro could arrive by 2025. And while the Bank of England has not yet taken a final decision, if it does, a digital pound could be ready by the end of this decade. If the Britcoin label sticks, senior Threadneedle Street figures will be hoping it's not mistaken for its less stable crypto predecessor with a similar name.