By Frances Coppola
Proposals for a world reserve digital currency broadly fall into three types. All are digital currencies, but the proposals differ in that they are:
Many people interpreted Facebook’s proposed Libra coin as an attempt to introduce a new global settlement currency, though many were skeptical that it would work.1 In Libra’s case, the proposal is to back the digital currency with existing reserve currencies and assets, principally the dollar—so its value would be dependent on central banks, especially the U.S. Federal Reserve. In such an arrangement, the dollar and other reserve currencies would potentially remain as world reserve assets, but international settlement would primarily take place using the digital currency.
Governments and regulators around the world were alarmed that a private sector organization could issue a major international settlement currency and manage a large proportion of global transactions.2 There was also concern that the size and content of the proposed reserve might enable such an organization to pressure governments to act against the best interests of their populations.3
It’s not yet clear what the future holds for Libra coin. But the possibility that Libra, or something like it, might replace national currencies for international transactions has attracted the attention of central banks. “The responses to cryptocurrencies and to stable coins are not necessarily about issuing our own digital currencies,” said Benoît Cœuré of the European Central Bank in a recent podcast. “The whole discussion is a useful wake-up call for the central banking community, and it makes us understand that we have got to be faster and we have got to step up upgrading our payment systems.”4 One outcome of the discussion might be to accelerate the pace at which international payments using existing central bank systems move to real-time, 24-hour, 7-day, all-year operation (24/7/365).
Such private-sector digital currencies backed by safe haven currencies, principally the dollar, might ease liquidity pressures in international payments, but would be unlikely to reduce the world’s demand for safe assets. There could still be a shortage of “safe haven” currencies and assets denominated in those currencies, particularly the dollar, especially in times of economic uncertainty. This would tend to keep their exchange rates strong.
According to the Bank for International Settlements (BIS), most central banks are conducting research into digital currencies and many are experimenting with creating their own. The BIS says that local conditions, such as Sweden’s imminent cashlessness, are driving the move towards central bank digital currencies (CBDCs), rather than any desire to significantly change the international monetary system.5
However, some central bankers seem to be looking further ahead. In a recent speech, Mark Carney, Governor of the Bank of England, commented that the dollar’s dominance, in effect, prevents the rest of the world, and especially developing countries, from controlling their own monetary policy. He argued that technology could be used to solve the problems of dollar hegemony. But he warned that simply creating a digital version of the dollar would not solve the problem. “When change comes, it shouldn’t be to swap one currency hegemon for another,” he said. “Any unipolar system is unsuited to a multi-polar world. We would do well to think through every opportunity, including those presented by new technologies, to create a more balanced and effective system.”6
Carney suggested that rather than a single CBDC, central banks could create a network of digital currencies. Due to developments in “faster payments,” most countries are already moving towards electronic payments settling in real time, 24/7/365. In most developed countries, the principal difference between electronic payment as currently configured and a CBDC is that the gateway to central bank settlement is via commercial banks. Introducing a CBDC could mean giving businesses and households direct access to the central bank, potentially disrupting commercial banks’ business models and affecting the transmission of monetary policy to the wider economy.7 However, as central banks might be unwilling to take on credit risk, banks could still retain an important role in trade finance and lending to households and businesses.
Once all central banks were producing CBDCs and settling domestic payments in them on a real-time 24/7/365 basis, they could link together so that cross-border payments could also settle instantaneously 24/7/365, with FX rates determined in real-time. The CLS FX settlement system already links 18 central banks for instantaneous FX settlement, although the time window is at present only 5 hours rather than 24.
In the system of networked CBDCs envisaged by Carney, there would be no dominant currency. But to prevent Herstatt risk, central banks would have to cooperate to ensure that there was always ample liquidity in all CBDCs. In this respect, it might not differ significantly from existing arrangements.
Suppose the world reserve currency was not “issued” by anyone. Perhaps the closest the world has come to this was the gold standard of the late 19th century. But at that time, European central banks (particularly the Bank of England) actively managed the stocks and flows of gold.8 Now, a digital currency has emerged which might have no such central control.
Bitcoin emerged after the financial crisis as an alternative to currencies created by central banks. Instead of being issued by order (“fiat”) of government or organization, bitcoins are created as a reward for digital puzzle-solving: the process of creating them is called “mining.” Bitcoins are freely traded on cryptocurrency exchanges, and this determines their market price. However, bitcoin has proved impractical as a primary international currency, since settlement can become extremely slow when transaction volumes are high.
But bitcoin advocates foresee a different role. In 2010, one of its pioneers, Hal Finney, said “I see Bitcoin as ultimately becoming a reserve currency for banks, playing much the same role as gold did in the early days of banking. Banks could issue digital cash with greater anonymity and lighter-weight, more efficient transactions.” In Finney’s vision, there would be no need for central banks, because the digital cash issued by banks would be backed by bitcoin reserves.9
Bitcoin’s fixed supply—about 18 million have so far been mined and the total possible number of bitcoins is only 21 million—makes it an interesting choice as world reserve currency. At present, central banks can increase the supply of “fiat” currencies at will, which can result in runaway inflation. But in a bitcoin-based international system, banks or countries that issued digital currencies would have to restrict the supply of these currencies to the amount of their bitcoin holdings or face default if people called in their claims.10
For many economists, however, it is the fixed supply of Bitcoin that makes it impractical as a world reserve currency. They say that since demand would far outstrip supply of bitcoins, adopting it as global reserve currency would mean permanent deflation.11
Global digital currencies are already here, developed by the private sector. Central banks are responding to the challenge of private sector digital currencies by accelerating the pace at which international payments go real-time, and by looking into creating their own digital currencies. It may be that in time, one digital currency will emerge to become the new world reserve currency. Alternatively, perhaps the future might be a network of equal currencies in a highly liquid international payments world.
With 17 years experience in the financial industry, Frances is a highly regarded writer and speaker on banking, finance and economics. She writes regularly for the Financial Times, Forbes and a range of financial industry publications. Her writing has featured in The Economist, the New York Times and the Wall Street Journal. She is a frequent commentator on TV, radio and online news media including the BBC and RT TV.
1. “The Real Threat From Facebook’s Libra Coin,” Forbes; https://www.forbes.com/sites/francescoppola/2019/06/30/the-real-threat-from-facebooks-libra-coin/#53d3cb201dc5
2. “Facebook hits back at Libra criticism and vows to press ahead,” Financial Times; https://www.ft.com/content/81f9f978-e4b0-11e9-9743-db5a370481bc
3. “Libra isn’t just a cryptocurrency, it’s a threat to national sovereignty,” WIRED; https://www.wired.co.uk/article/facebook-libra-politics
4. “Innovation in payments: Libra, blockchain and crypto-assets,” European Central Bank; https://www.ecb.europa.eu/press/tvservices/podcast/html/ecb.pod190920_episode1.en.html
5. “Proceeding with caution – a survey on central bank digital currency,” Bank for International Settlements; https://www.bis.org/publ/bppdf/bispap101.pdf
6. “The Growing Challenges for Monetary Policy in the Current International Monetary and Financial System,” Mark Carney, Bank of England; https://www.bankofengland.co.uk/-/media/boe/files/speech/2019/the-growing-challenges-for-monetary-policy-speech-by-mark-carney.pdf
7. “Central banks should not issue digital currencies,” Financial Times; https://www.ft.com/content/79794966-d867-11e9-8f9b-77216ebe1f17
8. “The classical Gold Standard,” World Gold Council; https://www.gold.org/about-gold/history-of-gold/the-gold-standard
9. “Hal Finney on Bitcoin: In His Own Words,” Coindesk; https://www.coindesk.com/hal-finney-bitcoin-words
10. “The Bitcoin Standard,” Saifedean Ammous, Wiley; https://www.wiley.com/en-gb/The+Bitcoin+Standard%3A+The+Decentralized+Alternative+to+Central+Banking-p-9781119473862
11. “Game over, Bitcoin. Where is the next human-based digital currency?” Stanislas Jourdan; https://www.ouishare.net/article/game-over-bitcoin-where-is-the-next-human-based-digital-currency