Monetary and financial institutions have been pinning their hopes on a digital overhaul for several years. How distant the outcome depends very much on who you ask, but the form of our new digital lives is slowly beginning to take shape.
Digital currencies remain persistent but unproven
Central banks are, almost without exception, conducting research into developing their own digital currencies. The proofs-of-concept have largely shown that at least some form of central bank digital currency is technically deliverable.
However, several difficult questions remain to be answered. Some of these are technical, such as offline payments and whether they constitute payments without internet access, without telecommunications coverage or without electricity. But as a feature, offline payments are hugely important, particularly for central banks that view CBDCs as a means to improve financial inclusion.
Other questions are more strategic. For instance, what should a CBDC be setting out to achieve? The answers differ depending on the jurisdiction. For many in emerging markets, financial inclusion is the priority. In developed markets, central banks are much more widely split on the rationale. However, OMFIF’s 2023 Future of payments survey found the top motivation for developed market central banks was to preserve monetary sovereignty.
But central banks still have work to do to prove that CBDCs are the best means of addressing these concerns. Can financial inclusion be more simply addressed by the provision of basic bank accounts? Can monetary sovereignty be secured by statute?
One possibility is that, by entering the payments industry with CBDCs, central banks might be able to disrupt the incumbents, improving competition and pushing down fees.
At OMFIF, we believe privacy in payments will be a major battleground. Trust in the ability or willingness of state or state-adjacent organisations to protect citizens’ privacy is extremely low. Despite efforts of transparency and the publication of papers from several banks on their privacy-enhancing techniques, central banks face an immense battle to persuade citizens that CBDC is not simply an operation to snoop on spending habits.
This is a winnable battle for central banks. The first step should be to raise awareness of the degree to which payments data are already being monetised by service providers and to present privacy-focused CBDC as a solution.
Crypto markets weather another crisis
Cryptoasset markets have finally steadied the course after the collapse of FTX. In the US, regulatory clarity is yet to occur, but there is hope that legislative clarity will emerge in 2024.
Its shape has yet to be fully determined. The contention concerning whether stablecoins will be overseen federally or by individual states remains fierce, as does the struggle against crypto in illicit finance. But it is hoped that it establishes a framework through which cryptoasset service providers can safely ply their trade on US soil.
There is also an outside chance that regulatory clarity in the US might enable the export of higher standards of oversight around the world. This could, in turn, work to curtail the fraud and market manipulation that remain rife in the asset class.
Rubber hitting road with digital assets
The campaign to improve operations in capital markets via new technology, particularly distributed ledgers, is beginning to deliver results. The slew of experimental blockchain bonds emerging in Europe is a long way from producing a functional market, but across the pond, efforts to tokenise exchange-traded funds and repo operations are yielding tangible results.
We are a long way from delivering the $5tn tokenised world that Citi foresees emerging by 2030, but progress is encouraging.
Again, questions remain unsolved. In what asset classes do people want delivery-versus-payment to eliminate settlement risk, and in what markets will people prefer net settlement? Should financial markets run on public blockchains, where unknown validators (including North Korean ransomware hackers) earn transaction fees? Is there a safe way to allow assets issued on different blockchain protocols to move seamlessly between them?
Progress is being made in both primary and secondary markets, but as yet, these developments are taking place in isolation. Perhaps 2024 is the year when the connection is made and natively digital securities begin to be a functional market.
Public and private divergence on blockchain
While blockchain has existed now for around 14 years, it has been on the radars of most forward-thinking monetary and financial institutions for almost 10. Sceptics say it has yet to prove its value and some of the attempts to deploy it – such as Australia Securities Exchange’s blockchain securities settlement attempt – have been less than encouraging.
Many in the private sector are doubling down on it, however. PayPal launched its own stablecoin, Swift is doubling down on the technology and commercial banks like Société Générale’s Forge are rolling out stablecoins of their own.
In the public sector, however, decision-makers are less than convinced. Only 28% of central banks surveyed saw any future for blockchain in payments. The rest either said they did not or that they were unsure.
Perhaps 2024 will be the year where central banks begin to follow the private sector’s lead and buy in to the promises of blockchain. But given experiments like Project Hamilton eschew the technology, perhaps they are just as likely to feel that if blockchain were going to prove its worth, it would have happened by now.
Lewis McLellan is Editor of the Digital Monetary Institute at OMFIF.