Collision or coexistence: Can CBDCs and crypto live side by side?

Transcript

Angie Lau: From Singapore to Spain, Russia to China, all central bankers and regulators seem to be keeping a rather close watch on crypto assets. But will 2022 bring greater clarity and make the path to crypto assets clearer? Will Mexico actually be able to launch their own digital currency in less than two years from now? And the U.S. Federal Reserve just released its long awaited report on CBDCs — our first opportunity to dissect it and analyze the Fed’s positioning on central bank-backed digital currencies.

Welcome to Word on the Block, the series that takes a deeper dive into blockchain and the emerging technologies that shape our world at the intersection of business, politics and economy. It’s what we cover right here on Forkast. I’m Editor-in-Chief Angie Lau.

Well, today we’re in conversation with Josh Lipsky, GeoEconomics Center director at the Atlantic Council — the Washington, D.C.-headquartered think tank that closely monitors international security and global economics. There’s none more important, in our view, than what we’re talking about right now.

Thanks for joining us on the show, Josh.

Josh Lipsky: Happy to be here. Thanks for having me.

Lau: It’s a little interesting that even a few short years ago, we weren’t even talking about this. This was not on anybody’s radar. And yet, when Forkast first started, this was one of our very first stories — talking about China’s efforts in central bank-backed digital currencies. Where we saw it then to where we saw it now has been unchanged, which is that this is dynamically going to change how the world is going to be shaped in the future. I think it’s one of the most important issues of our age, and it’s incredible to see that in a few short years, the world has absolutely caught up, woken up.

You’ve been part of this conversation for a long time now. How do you see this evolution?

Lipsky: Well, I fully agree with you on how critical this issue is, and you only have to go to the beginning, when you talked about us at the Atlantic Council, an international affairs think tank. Why are we at the Atlantic Council spending so much time on digital currency? Because it’s one of the most important foreign policy challenges for the United States and for the entire world as we look at the decade ahead, the future of money.

And it’s pretty auspicious to have this interview today, because Facebook just made their announcement that they’re likely to sell off the Diem assets. And, of course, (it was) that announcement of Diem’s predecessor, Libra, years ago, which really elevated this issue in the public consciousness, got the Fed thinking about central bank digital currencies, got countries around the world thinking about central bank digital currencies, and got China accelerating their already existing central bank digital currency plan. And now, when we look at China, 250 million users are in a pilot project — but I use that term loosely, because 250 million is a lot of pilot — on the world’s most advanced central bank digital currency.

And the most important thing — and we’ll dig into this — is that it’s not a ‘China alone’ story. What we evaluate at the Atlantic Council are 87 central banks around the world in some phase of development. When I started this project — when we started this project two years ago — (there were) 36 central banks. So, it shows you the acceleration, it shows you the interest, and it shows you that central banks don’t want to be left behind in this race for the future of money.

Lau: Packed in there is a lot of nuance in accelerating plans — people suddenly starting to talk about it. But therein lies a concern about threat — a threat against control of current sovereign interest in money itself.

Why is there such a concern about who controls what? And, really — the debate is kind of circling this, and this is where it’s hard for people, the average person who’s ultimately going to be at the core of this product, it’s hard for people to (assess the) impact — what is the threat here?

Lipsky: Well, think about it from a central banker’s perspective. Why is it, over the last two years, there’s been such a rapid acceleration in interest in having a central bank digital currency? There are two reasons.

One is the pandemic. It became very clear to governments that they needed a faster, better way to transmit both monetary and fiscal policy to citizens, so that was the primary driver — we need to get money to people more quickly. We have antiquated systems to do it. That was a global phenomenon.

And the second is the rise of cryptocurrencies. Central banks fear losing monetary sovereignty. That is their mission. That is their mandate. If they don’t have purview within their own economies of how money is being spent, how it’s being transacted, what’s actually happening in sales and assets and speculation and investment, they lose what they see as fundamental to their job and economic stabilization. So, the two forces at once — the rise of crypto and the pandemic — is what has generated so much interest in a central bank digital currency.

Lau: Different countries have different versions and different definitions of what a digital currency should look like. We just got the report out — the Fed Reserves report called ‘Money and Payments: The U.S. Dollar in the Age of Digital Transformation.’ There’s a lot of pros here. There’s a lot of cons here. First of all, I think one of the big critiques of this paper is that it didn’t say much. It was not definitive in tone. It was still very speculative, and it feels very slow. Your reaction?

Lipsky: I’ve seen that critique, and I disagree with it because I think it misunderstands how this could have gone. Folks were expecting the Fed to come out and say, ‘We’re doing a U.S. digital dollar, a U.S. CBDC.’ That was never going to happen.

On the other hand, it was plausible that this Fed paper could have come out and said, ‘We’re not doing a U.S. CBDC.’ And if you look at some of the commentary from some of the (Federal Reserve) governors in the months leading up to this report, that was an indication — and there’s certainly a strain of that within the Fed. But this paper didn’t say that. To me, it was surprisingly positive on central bank digital currencies. It listed all the positives that those of us who track pilot projects around the world see — the ability for financial inclusion, the ability for faster payments, the ability to transmit government stimulus, the ability to pay taxes… the things we often talk about as the potential benefits of CBDCs. And then, as it should, it went through the risk. It talked about privacy, it talked about cybersecurity, it talked about disintermediation of the commercial banks. And in each of those [respects, it] said these risks can be mitigated by design choices.

So, to me, as someone who follows this issue really closely, that paper read in the language of those of us who believe that CBDC is a very useful tool — and I sort of picked up on some of the signaling, even though, agreed, it did not have a lot of specifics, and there’s a lot left to debate here — it was actually surprisingly positive, because it made the base case for CBDCs that’s being made by those countries that do pursue pilot projects.

Lau: What happens next?

Lipsky: From the U.S. side, the Fed was very clear. They want congressional authorization, and that’s the next process. I was heartened to see that there was bipartisan support the night the paper came out for moving forward on a U.S. CBDC. That wasn’t the case even six months ago — there was skepticism. What that means in practice is a very much an open question. Does there have to be an amendment to the Federal Reserve Act? Is there standalone legislation? But there has to be some guidance from Congress that says, ‘Yes, you should do this,’ at least on a pilot basis. That’s going to take months to play out as that gets drafted and debated.

In the meantime, we’re going to get a technical white paper — and this is what a lot of the international community is waiting on from the Boston Federal Reserve. They’ve been doing a multi-year project with MIT (the Massachusetts Institute of Technology) on what a U.S. CBDC could look like from a technical perspective. They’re going to release that in the coming weeks, and I think it could be a very significant moment in the evolution of central bank digital currencies, because they’re trying to solve a lot of problems that countries are trying to solve that we monitor here (at the Atlantic Council). How do I scale? How do I maintain anonymity? How do I maintain cybersecurity? Can I do offline payments with these systems? And if Boston and MIT are able to answer some of those questions, I think it’s going to give the U.S. a very powerful model to do some of the international standard-setting they want to do, even as their own CBDC could take years to get to market.

Lau: And I think one of the big concerns — even in the current political environment — is trust. How does one talk about CBDCs when in fact baked in is obviously KYC and identification, financial privacy… all of those issues that you’ve expressed as being concerns? Do you think that trust, or concerns about trust, are going to allow us to have a robust and healthy discussion about financial privacy, about identification, and about that kind of responsibility to the consumer.

Lipsky: This is the key question that you ask, and there’s two sides to it. One is trust from a government side about AML, KYC, illicit finance… How can we make sure these are safe and not being used for illegal activities? And the Fed paper and other research has got into this, and they make very clear we need an account-based system — one that verifies identity in some way, not token-based. And we need to make sure this goes through the commercial banking and other private service payment providers. We do not want to do this as the Fed. We don’t want a Fed app on people’s phones. By the way, every central bank in the world, of the 14 pilot projects we track, they don’t do it themselves, either. They work through the commercial banking and other fintech providers to distribute it, and they basically outsource some of the identification and verification and security to the companies and businesses that are used to doing this already.

But then the other side of the coin is privacy. How do I ensure privacy? And the Fed paper got into this a little, but there’s a lot more to be said about this. Because when people say, ‘Why is the West so far behind China in developing a central bank digital currency?’ That’s because the ECB (European Central Bank) and the Bank of England and the Fed and the Bank of Japan are thinking a lot more about the privacy codes than the People’s Bank of China. And they have to maintain not just the technical elements to make sure there’s anonymity in transactions, but also ensure public confidence in that. It’s one thing to say, ‘Yes, we figured out a way that the Fed is not going to be able to see what you spend money on.’ It’s another to get everyone using a U.S. digital dollar to believe that. These are really the public buy-in, because you have to make a CBDC something that people want to use. We often forget that in this debate — we talk about, ‘it has to do this and it has to have AML, KYC and there have to be caps on it’ — but somehow people forget that you also need to make sure people use it. Otherwise, what’s the point?

Lau: That’s exactly the kind of situation we’re seeing right now in China — but we’ll touch on that a little bit later. But as you review this space, the Fed has the paper out. As you said, the ECB is looking into it, everybody is looking into it. And then, at the end of December 2021, the Mexican central bank confirmed the circulation of CBDCs by 2024. That’s a short two years away, considering all the other countries exploring CBDCs. In your view, which country will likely launch its digital currency next?

Lipsky: It’s a great question. First of all, on the Mexican announcement, which was done via a tweet, we were all just trying to enjoy the Christmas break without any CBDC news, and then this breaks because Mexico was one of only two G20 countries that had not announced any CBDC plans — Mexico being one and Argentina being the other. And now Mexico, of course, announced their plans. But all they had was the tweet, so a scramble was on talking to Banxico (the Bank of Mexico) —  ‘What’s going on? What’s happening?’ So, we quickly got some more details on that. And, as you say, they do plan to bring something to market within two years.

When we look at economies that are ready to do this, of course, one is Sweden and the Riksbank, the oldest central bank in the world. They have an ongoing pilot project. They’ve had a lot of success with it, and we think that’s going to scale up in the year to come. So that’s one we look at closely.

The second is South Korea. South Korea is one of the most significant G20 economies to be advanced in their pilot stage. They had a successful completion of their pilot project announced just this week. And the really interesting thing about South Korea is that they’re using a permissioned DLT (distributed ledger technology) system, which not all central banks are using. So, if they can find some success with that model, I think it’s going to be very influential among the rest of the G20, that are a little further behind in this process.

Lau: So we’re going to start seeing people and nations experience CBDCs. We’re going to pick and choose the best practices. But in your view, as you kind of review the landscape, what are the best practices you see emerging right now that are critical to the thinking here?

Lipsky: There are a couple trend lines that emerge when you look at global CBDC development, and the Fed paper picked up on this, although they didn’t say it explicitly.

The first is that countries are trying to figure out a way to use some kind of permissioned DLT in the system. So China’s an exception, with a completely centralized ledger, a traditional model. But if we look at Nigeria and the e-Naira, if we look at what’s happening in the Bahamas, and now if we look at South Korea, there’s an indication that, ‘Hey, let’s try to actually use the technology here that makes these things faster if we can make sure of their cybersecurity and safety around them.’

The second is accounts versus tokens — and accounts is the trend line. Yes, there are some countries that do tokens — there’s only two, by our estimation. Most countries are really — 75 are — doing accounts, and that’s for the reasons we discussed. They have to find a way to deal with illicit finance. They have to find a way to meet AML/KYC concerns. So accounts is really the trend line.

Then the other trend line that I think is really important, as we said, is using the commercial banking system, so, intermediated — not doing it directly to consumer, and having some caps on the CBDC, because one of the criticisms of a CBDC is that in a bank run situation, in a crisis, folks will flee to the safest asset, which will be perceived as the central bank’s liability. And so these countries, like the Bahamas and others that have rolled this out more wide-scale, have caps on the amount you can have, and that has a lot of benefits, and one of them is to prevent a bank run in case of a crisis. So, these are some of the trend lines we see in CBDC development, but I would say it’s still very much an open field and there’s a lot of room for development and innovation. Nothing is fully baked in at this point.

Lau: Nothing is fully baked in. That is absolutely true. What does [the Fed paper] suggest about the likelihood of a U.S.-backed digital dollar and how it contrasts against what we’re seeing coming out of China?

Lipsky: This is really what’s on the mind of so many policymakers in Washington right now, and which has spurred so much activity here in Washington and beyond on central bank digital currencies. This has been a project of mine for years. I came from the IMF before the Atlantic Council, where we were studying these issues, and at that point it was nascent — 2016, 2017… only a handful of central banks… and now we see proliferation around the world.

From the Fed perspective, this is still years away, so we’re not in a digital dollar that you’re going to see in 2022 or 2023. Maybe some pilot projects, potentially at the back end of 2023. But it’s important to understand that just because U.S. citizens are not using a digital dollar does not mean the Fed and Treasury and the U.S. government will not try to exert enormous influence on the development of CBDCs around the world — and they said exactly that in the paper. It’s something we’ve been advocating for at the Atlantic Council. You can be an international standard-setter and the issuer of the world’s reserve currency, as the dollar should be, even if you don’t have a product to market yet. And so I think that’s where you’re going to see the really rapid step up from [the U.S. government] in the months to come.

Of course, they have to have an alternative model to bring to the table to influence that conversation, and the biggest model out there — just as you asked about — is the e-CNY. The e-CNY is very different than any other central bank digital currency we look at. One, it’s a fully centralized ledger, not using any permissioned distributed ledger technology or anything like that. Two, they just announced, as of a month ago, you can download e-CNY directly from the People’s Bank [of China]. And, as we talked about before, that is rare. Most central banks do not want anything to do with direct, customer-facing interaction, and in the beginning, e-CNY did not either. They were distributing digital yuan through Alipay and WeChat Pay, and they’re still doing that. But now they’re adding PBOC direct access, and I think that’s a very significant development, and we’re going to see it throughout the Olympics.

Lau: That is pretty significant, in that one of the concerns about a CBDC is that you would be disintermediating the banks, which could then trigger risk in terms of liquidity access for the consumer. Where are you going to get credit? Where are you going to get cash? Where are you going to get your loans if the only bank that you can go to to access cash is the central bank? China might be a different story here.

Lipsky: As with so many things, China is a bit of a different story, and their considerations for an e-CNY, and the way they interact with their commercial banking system, is different than a lot of other economies, and they’re willing to take on some of the risk. I personally think, because they realize that even if that would happen — and it’s only small-scale now, the amount of people who are downloading directly —  they could through the back end handle these things through lending to the commercial banks. So, they feel like, for them, it’s worth it.

We have to understand China’s ambitions within e-CNY, and this is misunderstood in the West. We see it from a U.S. perspective as threatening the dollar. My personal opinion is that’s low down on the list of why China is pursuing their central bank digital currency. The first is surveillance of private information. Data that can be gained from a central bank digital currency is extraordinarily valuable to the (Communist) Party, to the People’s Bank, to the finance ministry. They want that data. They want to be able to collect it. The second are the reasons a lot of central banks do it — easier transmission of fiscal and monetary policy. They want to find more effective ways to influence their economy. So, it’s really these domestic reasons more — to me — than the international reasons that are driving China forward, and I think that’s often misunderstood.

Lau: There’s also an internationalization perspective on e-CNY. If you’re able to almost export e-CNY to your trade relationships in your Belt and Road initiatives across the region, could that be a way for China to also counter the global hegemony of the U.S. dollar?

Lipsky: I think the answer is Yes, with a significant But. Yes, China has this ambition to use e-CNY in Belt and Road projects in bilateral lending. And also — and we should talk about this — the difference between their retail e-CNY and their wholesale — their bank-to-bank e-CNY projects, which are different. China has that ambition, but I don’t see China — in the near term — one, being overly successful and eating away at the dollar hegemony because of all the restrictions that the traditional yuan has and capital controls and things that make it difficult to alternate who the world’s reserve currency is, but also because China wants to help chip away at the dollar but not replace the dollar. It would like the dollar to not be the only game in town. I think it would like a more multipolar currency system, but I don’t think China wants to take on the responsibility — nor can it, now — of being the world’s reserve currency. What I do think they want is ways around (international payment network) SWIFT, ways around sanctions, ways around the traditional bank-to-bank payment systems (so) that they won’t have to always exchange through dollars. And I think they see a lot of benefit in that. And you only need to look at what’s happening with Russia right now, and the possibility of sanctions, to understand why countries might want to get away from dollar-based transactions.

Lau: Technology has, as you’ve said, Josh, become both a weapon and a target. How is geopolitics playing a role in how governments are viewing access and acceptance of crypto markets? Let’s pick back up on Russia — Russia and what’s happening both on the ground in Ukraine and then also the central bank issuing almost an edict to a flat ban on crypto activity in Russia. What’s your view as crypto and geopolitics collide?

Lipsky: Yes, crypto and geopolitics have collided and they will not un-collide for decades to come. They are now enmeshed. It was very interesting. The central bank, who have been thinking about these issues for a long time on the crypto side, and Russia being the third-largest miner of crypto now. They banned it, but there were kind of mixed signals coming from (Russian President Vladimir) Putin afterwards, because there’s crosscurrents within the Russian economy now. So, it’ll be very interesting to see how much that ban is actually enforced in practice, because there are a lot of different financial flows in and out, and Putin and the government are looking for alternative sources — as we discussed — outside the dollar, and crypto is a potential avenue for that. So, while the central bank said what they said, I’m not totally convinced that we’re going to see that ban in practice — very different than in China, when the ban came into force, that went into effect.

Lau: The ban is one thing, stablecoins is another, and that’s also on the bull’s eye of so many regulators because — well, you take a look at what a stablecoin actually is, which is in its most ideal phase, a one-to-one to a U.S. dollar or another fiat-backed crypto. And so, a lot of countries feel like this is almost the Trojan horse to circumvent even domestic efforts in CBDCs from the private enterprise side. What’s your view here?

Lipsky: That fear we hear from both central banks and private actors around the world in terms of dollar-backed stablecoins, and all stablecoins, but predominantly the dollar-backed stablecoins. Dollarization is an economic phenomenon that’s gone back decades now, and emerging markets are especially concerned about it — the rise of dollars, the inflow of dollars in their economy, and how they lose monetary sovereignty. So, digital dollarization is the new threat, and so they look at stablecoins and say, ‘Could that happen?’ And that’s why they’re so eager for the U.S. to regulate stablecoins, to manage this, and potentially have their own offering — a U.S. central bank digital currency that would sort of pair into this ecosystem and maybe limit the spread of these internationally. I think that’s something that’s going on right now.

The stablecoin companies, from their perspective, are aware of these concerns. They’re trying to discuss them, they’re trying to mitigate them with other partners. But the regulatory environment is so nebulous. It’s very hard to get a straight answer from any regulator on what’s allowed and what’s not right now. And it’s a bit of the Wild West when it comes to crypto and stablecoin proliferation.

Lau: Absolutely. Even if you just take a look at what’s happened with Diem. Once upon a time … that had great ambitions, but it triggered a lot of fear and it got shut down politically. The political storm that it triggered was too much, at least from the business side. But the current that was underlying behind that … almost sucked a lot of energy politically with stablecoins. 

And so, where are we now in terms of where the world is going, regardless of how governments view it, regardless of political efforts to squash, regardless of regulatory efforts? What, in your view, Josh, do you see emerging as a powerful trend that we should be all paying attention to?

Lipsky: A lot of folks who I talked to in the crypto space worry about CBDCs, and they see them as antithetical to the idea of cryptocurrency, which is, by definition, decentralized. So, you’re bringing in a central bank digital currency to what is, from its ethos, a decentralized network. I don’t see it that way. I see central bank digital currencies as actually being a stabilizing force in this ecosystem, and the Fed paper sort of went into this. It’s not about replacement, it’s about complementarity, and it’s about CBDCs and stablecoins and traditional crypto like Bitcoin coexisting, and giving consumers more options. And the key to making that work will be through wallets, will be through interoperability… so you can go on your phone and say, ‘I want to switch my Bitcoin for my digital euro, for my digital pounds. And now I’m going to travel to the U.S. and I want digital dollars. But the Fed doesn’t use digital dollars everywhere, so for my retail, I’m going to use USDC.’ This is the kind of ecosystem — and maybe I’m pollyannaish about it — that I think we can get to, because eliminating any of these isn’t the right way.

It’s not fair to tell central banks that they can’t innovate. They’re the issuers of fiat that the stablecoins are based on. And it’s not fair to tell crypto and stablecoins that have innovated in this space and spurred so much action that they have to be pushed out of the market. So I see the best case scenario as a digital currency ecosystem regulated — and that’s the key — regulated, international standard-setting. And that’s what we’re missing right now.

Lau: I could not agree with you more. I think it’s a hybrid world. Technology and innovation have surfaced a lot of the problems that we’ve been okay with for far too long and have provided some real clear answers. Both the market is speaking from a consumer point of view, but also we have to think in the macro. There are individual efforts and interests. There always will be.

But in the grand scheme of things, we all live in an ecosystem that’s designed to ultimately serve the best of us. And I truly appreciate you sharing all the best knowledge that you’ve acquired over the past couple of years.

Before I let you go, Josh, how do you view 2022? Where do you see this all going? If there was one prediction that you could make in the CBDC crystal ball, what would it be?

Lipsky: I believe 2022 is the year of the cross-border test on CBDC. There’s a lot of domestic advancements in CBDC, as we’ve measured in 87 countries, but there’s just nascent testing between banks, wholesale CBDC. There are about five projects around the world — Project Dunbar with Australia and South Africa, China with their mCBDC Bridge project… I think you’re going to see a lot more of those in 2022, because whatever happens on the domestic retail front, banks want to be able to send money to each other faster across borders. And that cross-border testing of CBDC is going to be a really interesting development in the year ahead.

Lau: Josh Lipsky, GeoEconomics Center Director, Atlantic Council, thanks for joining us today.

Lipsky: Thanks so much.

Lau: That was Josh Lipsky, and thank you, everyone for joining us on this latest episode of Word on the Block. I’m Angie Lau, Editor-in-Chief of Forkast. Until the next time.