The European Central Bank this week unveiled a working paper on the pros, cons, and economics of implementing central bank digital currency (CBDC). He suggested that CBDCs could help stave off the dominance of BigTech companies in the payments market due to “network externalities” surrounding the use of a medium of exchange.
Ultimately, the paper posits that the CBDC may be “the only solution to ensure a smooth continuation of the current monetary system.”
The threat of digital platforms
The working paper begins by noting the growing interest in CBDCs, which are currently being explored by central banks around the world. They have been launched to date in two countries: the Bahamas (Sand Dollar) and in Nigeria (eNaira).
The report contextualizes their growth and potential for adoption within the larger phenomenon of a rapidly digitizing world and economy. This has led to digital platforms becoming dominant business models and an increasing role for data and software. However, it has also contributed to an anti-competitive environment that centralizes digital market power with a handful of tech giants.
This tendency towards centralization is caused by “network externalities”, meaning that users are drawn to these platforms precisely because others use them.
“At the extreme, this can result in a winning outcome with a single dominant platform in a particular market segment,” the report explains.
Regarding crypto, the ECB fears that dominant platforms issuing digital currencies (ex. Diem) could use network externalities to become dominant issuers of private money. This could hypothetically challenge the monetary sovereignty of a national economy – its supremacy over the economy’s currency which acts as a store of value, a medium of exchange and a unit of account.
What a CBDC can offer
As a remedy, the report offers CBDCs as a tool that can ensure the continued practical use of public money in the economy. This could reduce the cost of payments, resolve frictions in financial intermediation, and improve the ability of the central bank to serve as a lender of last resort.
By protecting monetary sovereignty, a CBDC would help retain central bank control over monetary policy. If prices in the economy are denominated in a different currency, then any expansionary policy will simply create a surge of inflation without any increase in economic output.
“Theoretically, the monetary authority can ‘print’ unlimited amounts of national currency to support struggling financial institutions,” the report explains. “However, such liquidity support is no longer available if the liabilities are denominated in foreign currencies, which increases the risk of bank runs (even for solvent institutions).”
Facebook’s plan to launch Diem – a global dollarized cryptocurrency project – finally lack after repeated bouts of regulation and politics repel. Countries like France and Germany confirmed early on that they would block the project because of its potential to undermine traditional financial institutions.
Since its collapse, former Diem project manager David Marcus has moved on to working on Bitcoin. Primary cryptocurrency devotees, like Jack Dorseybelieve that it alone can challenge the global supremacy of the dollar.
Central bankers are not so concerned about this particular asset, however. Former Federal Reserve Chairman Ben Bernanke claimed in May that Bitcoin had already lack as an alternative currency. Later that month, the Central Bank of Sweden clarified his view that Bitcoin and Ethereum are not classified as currencies, primarily due to their volatility.
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