As central banks hustle towards issuing or adopting digital currencies, there are sharp and divergent views on how best to go about this.
Privately issued currencies like Bitcoin took the definitive first steps and they were rewarded with an unassailable lead even as they have their shortcomings. Central banks that only recently (and perhaps rather belatedly), began attempts to enter this space, appear motivated by the desire to overtake such established players in a very short space of time.
It is logical that after decades of being accustomed to a monopoly status central banks will want the old order to subsist even in the digital space.
Of course, it will not be easy for central banks to achieve this feat of retaining currency issuing monopoly even in the digital space because they lack the experience and expertise. It is for this reason that some within the central banking circles now admit the futility of opposing or competing with privately issued digital currencies or cryptocurrencies.
Rising Case for CBDCs
For instance, the Official Monetary and Financial Institutions Forum (OMFIF), an independent think tank for central bankers, is now urging its members to embrace changes to the monetary system brought about by private currency issuers.
In a study, which was released in late 2019, OMFIF also says it is in the central banks’ best interest to keep abreast with developments in the digital currency space or risk being driven out of the financial system altogether.
While innovation is generally inevitable, it had not reached the doorstep of central banks for decades until recently. Bitcoin and so-called altcoins like Aglo are some of the financial technologies that initially began to shake the global financial system. However, it seems the proposed Libra stablecoin might have been the catalyst that started the frenzied trials or study of central bank digital currencies (CBDCs).
Now central banks realize they must respond to this by integrating or redesigning their respective platforms so that they become compatible with the present day realities.
Part of the introductory section of the OMFIF study reads:
“Whether or not central banks like the sight of these developments – which generate an inherent threat to their senior position in the financial system and to their monetary sovereignty – they must remain alert to shifts in payments habits. The discourse on CBDCs and related trials has accelerated in recent years. Central banks are responding to the reality that digital currencies, either privately or publicly issued, will be an unavoidable part of the global monetary system. It is in central banks’ best interest that they are neither left behind nor displaced.”
This is an ominous warning and it appears many central banks including less influential ones are taking heed. Leading central banks are already running trials of CBDCs with a view of fully deploying them.
Create or Outsource?
Unfortunately for central banks, they are already at a disadvantage because they spent years believing that this technology—the blockchain— did not pose a threat. However, now they simply have to issue digital currencies yet they lack the expertise required to successfully deploy a CBDC. It means something has to give.
In fact, according to the same report that was co-authored with IBM, the OMFIF concludes that a central banks’ best chance of deploying a successful CBDC might be through partnering with financial technology firms that are already working in the blockchain space.
Practically, the operation of a CBDC is likely to rely on some sort of public-private partnership. Central banks could outsource the distribution of the CBDC to private financial institutions, which could also be involved in the on-boarding of users.
So while many financial technology firms have focused on solutions that solely accommodate their respective coins and tokens, it is also true that a few of them have created protocols that accommodate clients like central banks.
Yet the onus is on central banks and nation states to admit they lack neither the expertise and resources needed to study and create their own blockchain. Tech firms can only respond to the needs of a central bank if it chooses to come forward.
Marshall Islands Case
This was certainly the case for the Republic of Marshall Islands (RMI) which wanted a digital solution that was ready for use. RMI’s openness and willingness enabled it to scout for one of the best platforms available, the Aglorand, an open source public blockchain based on a pure proof-of-stake consensus protocol that supports the scalability and transaction finality.
According to David Markely, Director of Business Solutions at Aglorand, that attitude is what made an island nation to become one of the few sovereign states to take the lead on CBDCs. Markley, who spoke at a recent Global Blockchain Business Council (GBBC) Virtual Members Forum, added that RMI— which is now currently piloting its CBDC— chose Aglorand as its partner because the latter’s blockchain met its list of priorities.
RMI, which has set itself a lofty goal of being at the forefront of innovation, chose Aglorand as its blockchain partner because the technology firm was already building solutions for countries that may not have the wherewithal or time to create their own digital currencies.
RMI also believes Aglorand’s blockchain solution will help it achieve the goal of reducing the cost of remittances as well as creating a highly efficient currency management and distribution system.
The island nation also understood that for all the expertise it might have in the area of monetary policy management, there are some capabilities that its central bank simply does not or cannot possess.
Nevertheless, other states might have other concerns that go beyond the transaction costs or scalability of a blockchain.
Many financial regulators, and indeed governments, are adamant that the prestige and responsibility of issuing a currency, which acts as both legal tender and as a medium of exchange, must be reserved for central banks alone.
François Villeroy de Galhau, the governor of the Banque de France, is the latest high profile central banking figure to re-emphasize this point. Villeroy de Galhau reportedly claimed in January 2020 that ‘currency cannot be private, money is a public good of sovereignty.’
Such strong sentiments highlight the extent of the challenge that private fintech companies still face.
Moreover, some have correctly argued that a permissionless public blockchain is unsuitable for institutions like central banks, governments or banks, which must always carefully control who can access their data or comply with complex regulatory requirements.
Aglo’s Co-chain Architecture
Aglorand has been developing a solution that might assuage some of these concerns too. Through its co-chain architecture, Aglorand has created a dual system that enables organizations to isolate and control sensitive data on a private blockchain while still safely interacting with the world at large through an interoperable public blockchain.
The architecture enables the members of a permissioned chain to work most securely and efficiently not only with each other, but also, while retaining maximum autonomy, with the Algorand permissionless chain and members of other chains as well. As RMI’s case will show, central banks can still enjoy the best of both worlds by choosing Aglorand as a partner.
Admittedly, different central banks will have different priorities but as OMFIF has observed, they all share a common objective, which is adapting to the changing financial environment. The Aglorand blockchain is one the best platforms out and central banks must understand their priorities first before requesting a tailor made solution.
Central banks still serve a purpose but that will only happen if they choose to adapt and innovate. Indeed, it was the threat posed by the proposed Libra stablecoin that cajoled some central banks to seriously look into CBDCs. The threat may have subsided for now but central bankers and governments can be certain that another one is coming and this time they may not have the means to push back as they did against Libra.
It is imperative therefore for central banks to be ready for this by adopting tailor-made solutions like Aglorand’s co-chain infrastructure.
Terence Zimwara is a blockchain writer, content creator and crypto analyst who has contributed to a number of international publications and news sites like Coindesk, BitcoinAfrica, Coin Info News publications. He is also involved in efforts aimed at raising awareness about the potential impact of this technology in communities across the African continent.