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A new report from the Bank for International Settlements (BIS) has said that central bank digital currencies (CBDCs), not crypto, will be the foundation of the future monetary system.
In its 2022 Annual Economic Report, the BIS considered what monetary and payments technologies are likely to be adopted by central banks and other institutions in the years ahead.
While recognising crypto’s contribution to financial innovation, the BIS nonetheless found that all of the new advances pioneered by crypto would be better harnessed using CBDC.
“Programmability, composability and tokenisation are not the preserve of crypto, but can instead be built on top of CBDCs, fast payment systems and associated data architectures,” the report notes.
Or as Hyun Song Shin, head of research at the BIS, put it: “Anything that crypto can do, CBDCs can do better.”
The BIS devotes considerable space in the early part of its report focusing on why crypto cannot deliver the decentralised, permissionless monetary system that it promises.
In the eyes of the BIS, recent events such as the collapse of TerraUSD, an algorithmic stablecoin, have revealed the gulf between crypto vision and crypto reality.
“The implosion of the TerraUSD stablecoin and the collapse of its twin coin Luna have underscored the weakness of a system that is sustained by selling coins for speculation,” said BIS.
“In addition, it is now becoming clear that crypto and DeFi have deeper structural limitations that prevent them from achieving the levels of efficiency, stability or integrity required for an adequate monetary system.”
As the BIS noted in a previous report, crypto is prone to fragmentation into an ever-increasing number of competing blockchains, thus undermining the network effect of each.
Moreover, the BIS argues that crypto applications cannot scale without compromising security, as shown by high fees, congestion and long transaction times.
Finally, the crypto markets are also home to many centralised and unregulated intermediaries, which add to the lack of transparency and user protections throughout the space.
“These structural shortcomings are unlikely to be amenable to technical fixes alone,” said the BIS.
“This is because they reflect the inherent limitations of a decentralised system built on permissionless blockchains.”
Sound money
The BIS argues that a system grounded in central bank money offers a sounder basis for innovation, and can ensure that services are stable and interoperable, both domestically and across borders.
Wholesale CBDCs using permissioned distributed ledger technology (DLT), for example, are expected to become a driver of innovation in settlement infrastructure.
In future, the BIS said that wholesale CBDCs will offer programmability and atomic settlement, so that transactions are executed automatically when predetermined conditions are met.
They will also allow a number of different functions to be combined and executed together, thus facilitating the composability of transactions.
Similarly, the tokenisation of bank deposits could allow decentralised settlement using CBDC.
As the BIS points out, this could facilitate new forms of exchange, including fractional ownership of securities and real assets, as well as payments.
Another “core feature” of the future monetary system, according to the BIS, will be retail CBDCs and retail fast payment systems (FPS).
Both retail CBDCs and FPS allow for instant payments between end users, through a range of interfaces and competing private payment service providers (PSPs).
Retail CBDCs and FPS share a number of other features, and can thus be seen as lying on a continuum.
Both are supported by a data architecture with digital identification and APIs that enable secure data exchange, therefore supporting greater user control over financial data.
By providing an open platform, they promote efficiency and greater competition between private sector PSPs, facilitating lower costs in payment services.
Another major benefit, according to the BIS, is that both can support financial inclusion for users that currently do not have access to digital payments.
Given the similarities of both retail CBDCs and FPS, a question not addressed by the BIS report is why you would need both.
VIXIO analysis shows that instant payment systems are live in more than 70 markets around the world, and that these markets account for more than 90 percent of global GDP.
