As Crypto-Crisis Metastasizes, Big Moves Are Being Made on CBDCs

As Crypto-Crisis Metastasizes, Big Moves Are Being Made on CBDCs 1

Leading the charge are the world’s two most populous nations, China and India, which between them account for roughly three out of every eight people on the planet. 

More than $2 trillion has been wiped from the “value” of the crypto market in the past year as the final stages of one of the world’s biggest ever pump-and-dump schemes play out. The fallout from the epic collapse of FTX (covered in depth by Yves here, here and here), has now spread to Binance and Coinbase, two of the world’s largest cryptocurrency exchanges.

Coinbase’s stock is down an eye-watering 86% so far this year and its bonds are trading close to 50% on the dollar. As for Binance, its books were just described as a “black box” in a damning Reuters special report. The value of its digital token is down 8% over the past month and 50% so far this year. Depositors have yanked a whopping $9.7 billion from the exchange in the past week alone, according to data compiled by DefiLlama.

One reason why investors are spooked is a recent report from Reuters asserting that the US Justice Department is mulling going after Binance, its CEO Changpeng “CZ” Zhao and other senior executives for an assortment of financial crimes including “unlicensed money transmission, money laundering conspiracy and criminal sanctions violations.” That followed news of the arrest last week of Sam Bankman-Fried, who has been charged with money laundering and fraud, among other violations.

Now that the horse has bolted and trillions of dollars of investor funds have been lost, noises are finally coming from Congress about the need to regulate cryptos. This comes on the heels of Executive Order 14069, “Ensuring Responsible Development of Digital Assets,” which calls for “safeguards” to be put in place to “promote the responsible development of digital assets to protect customers”. Signed by Joe Biden on March 9, it also recommends creating a so-called “digital dollar” (more on that later).

It’s not just the US that is calling for sweeping regulation on cryptos. Yesterday (Dec. 19), the European Central Bank’s Vice President Luis de Guindos said that crypto assets need to be regulated at a global level to avoid loopholes in the global financial architecture. Last Wednesday (Dec.14), Germany’s financial market regulator BaFin made the exact same case, calling for global regulation of the crypto market to protect consumers, prevent money laundering and preserve financial stability.

While all this is playing out, to breathless, wall-to-wall coverage in the media, big moves are being made around the world on central bank digital currencies (CBDCs). And they are receiving virtually no coverage.

China and India Leading the Way

Leading the charge are the world’s two most populous nations, China and India, which between them account for close to three out of every eight people on the planet. No G20 economy is as far along the path toward implementing a nationwide central bank digital currency as China. Wired magazine noted last month that the Asian giant “is far ahead of the US and other countries, where the concept of an official form of digital cash is only at the discussion phase.”

The People’s Bank of China launched its first pilots of the digital yuan in 2019, and the CBDC is now being tested out in 23 of the country’s largest cities, including Shanghai, Beijing, and Shenzhen. In January this year, the digital yuan was given a promotional boost when visiting athletes and attendees of the Beijing Winter Olympics were invited to try out the digital currency. In September, the People’s Bank of China released the new digital yuan app for iOS and Android on domestic app stores, which is now freely available to anyone living in the 23 pilot cities.

Another major milestone was reached last week when China’s biggest mobile payment platform Alipay agreed to offer the app as an express payment option on its e-commerce platforms. Ant Group, the fintech powerhouse that runs the Alipay platform, is restructuring its business in order to comply with regulations imposed by China’s central bank, which recently set up an agency called the Digital Currency Institute to oversee e-CNY development, reports South China Morning Post, which itself is owned by Ant Financial’s parent group Alibaba.

While perhaps predictable, this move is hugely significant. Alipay, now in its 18th year of existence, is not just China’s but the world’s largest mobile (digital) payment platform, with over 1.3 billion users, 800 million more than Apple Pay.

Together with rival Chinese tech platform Tencent’s payment app WeChat, which has 900 million users, Alipay has revolutionized the way Chinese people pay for the goods and services they consume. Thanks to the ubiquity and popularity of mobile payment apps like Alipay and WeChat, coins and notes have largely disappeared from Chinese society. As an op-ed in China Daily proclaimed a few months ago, the cashless payment system is “now a reality” in China, thanks largely to “the e-payment apps and more than 1 billion smartphone owners.”

China’s government and central bank now want a piece of the action. The government already banned cryptocurrencies last year, ostensibly to curtail financial crime and prevent economic instability. Now the PBOC appears to be eyeing Alipay and WeChat Pay’s vast payment empires, though Beijing insists it is not treading on any toes. According to Shanghai Securities News, a subsidiary of Xinhua News Agency, the PRC’s official state news agency, while “some regard the digital yuan as a competitor to WeChat Pay and Alipay,” China’s central bank has “publicly refuted such claims.”

As the digital yuan inches closer and closer to becoming fully operational, the fear in other global capitals is palpable. Last week, Japan Times warned that “the digital yuan will have a significant global impact, as it will create the most extensive database of centrally regulated financial transactions.”

The head of UK intelligence agency GCHQ, Jeremy Fleming, warned in a recent speech that Beijing could use its digital currency not only to evade international sanctions but also to monitor its citizens. What he didn’t mention is that the Bank of England is also looking to develop its own CBDC with which it will also be able to also monitor (as well as control) the purchasing behavior of UK citizens. As is just about every other central bank on planet Earth, including the Reserve Bank of India (RBI).

“A Template for the World”

India already boasts the world’s largest biometrics-based digital ID system, the so-called Aadhar. By 2021 the Unique Identification Authority of India had issued 1.3 billion unique identity numbers (UIDs), covering roughly of the population. In 2017 the system was touted by “Nobel”-prize winning economist Paul Romer as a template for the world.

One of the masterminds of the UIDAI was Nandan Nilekani, the cofounder and nonexecutive chairman of Infosys, India’s second largest IT company. Lauded by Bill Gates as one of his so-called “heroes in the field” for having made the world’s “invisible people, visible,” Nilekani has in recent years been working with the World Bank to help other governments set up similar digital ID systems.

A national digital ID system like Aadhar is also a vital prerequisite for any country looking to roll out a CBDC, as the IMF admitted in June. And India, like every other G20 economy, is determined to roll out a CBDC.

To that end, the RBI on December 1 launched a pilot program to test a retail CBDC — i.e. one aimed directly at consumers. The program will initially involve four banks (State Bank of India, ICICI Bank, YES Bank and IDFC First Bank) and four cities (Mumbai, New Delhi, Bengaluru and Bhubaneswar). But in its later phase it will be extended to another four banks (Bank of Baroda, Union Bank of India, HDFC Bank and Kotak Mahindra Bank) and nine more cities (Ahmedabad, Gangtok, Guwahati, Hyderabad, Indore, Kochi, Lucknow, Patna and Shimla). The scope of the pilot program may be expanded further to include yet more banks, users and locations.

V. Vaidyanathan, the managing director & CEO of IDFC First Bank, one of the participating lenders, extolled the potential benefits of a digital rupee, including, I kid you not, saving India’s trees:

Today, India spends close to 5,000 crore rupees a year in printing physical cash. God knows how many trees we cut and how much print we consume in printing these notes. Moving to digital currency will be a huge gain for environment, and for our trees.

“Further, it’s easier to carry than cash, you can carry only that much currency in your pocket, it would be bulky beyond say 2,000-2,500. CBDC is currency in the same denominations, it is easier. And more secure too. If you lose your wallet you lose your cash unlike in digital currency. Over time this is a big gain. RBI has done a wonderful job putting this together, the concept, technology, blockchain, reconciliation etc. For the common person, this is more anonymous than the current and the traditional digital transactions, as these are wallet to wallet and not touching the bank account for every transaction.”

Western Countries Playing Catch Up

As the world’s two most populous countries expand their experimentation with CBDC, countries in the West are frantically trying to catch up. In the past month or so:

  • The New York Federal Reserve has completed phase I of Project Cedar, a multiphase research effort conducted with banking institutions such as Citi, HSBC, Mastercard, PNC Bank, TD Bank, Trust, U.S. Bank and BNY Mellon. The goal of the project is to “develop a technical framework for a theoretical wholesale central bank digital currency (wCBDC) in the Federal Reserve context through exploration of fundamental design choices and modular technical features.”
  • The UK government has announced it will “bring forward” a CBDC consultation to “explore the case for a central bank digital currency [CBDC] — a sovereign digital pound — and consult on a potential design”. The BoE has been conducting research on the viability of a digital pound for years now, although it still hasn’t publicly committed to developing one. In the June 2021 the UK’s then Chancellor of the Exchequer (now PM) Rishi Sunak announced that “under the UK’s presidency, the… G7 is launching a set of public policy principles for retail central bank digital currencies.”
  • The Bank of Japan has unveiled plans to start testing the feasibility of a digital yen with major Japanese commercial banks next spring. The news came just a few months after Sayuri Shirai, a former policy member at the BoJ, noted in an article that the central bank was putting its plans to launch a CBDC on ice due to the continued popularity of cash as a means of payment.
  • The European Central Bank (ECB) has announced plans to conduct “market research” for a “digital euro” in January 2023. Normally, market research focuses on customers, who in this case would be EU citizens, but here the target is to gather information from CBDC suppliers. As Euromoney notes, “most ordinary Europeans haven’t even heard of plans to issue a digital euro. Even in the mainstream financial sector, people are at best lukewarm about the idea.” But the ECB is nonetheless determined to plough ahead with its digital euro project and is planning to propose legislation for its adoption in early 2023.

Another nation that is moving hard and fast toward launching a CBDC is Brazil, whose central bank recently unveiled plans to conduct a pilot program next year involving some of the country’s largest financial institutions. The goal is to have the CBDC ready to roll by 2024. The central bank’s announcement follows the launch earlier this year of a QR-enabled national ID system by the Bolsonaro government.

From Reuters:

Speaking at an event hosted by the news website Poder 360, Campos Neto said the design of the central bank’s digital currency would encourage banks to tokenize their assets, with considerable efficiency gains.

“If the digital currency is actually a tokenized deposit, it inherits all the regulation that already applies to deposits,” he said, adding that it should not disturb monetary policy or hurt banks’ balance sheets.

Campos Neto said representatives of the International Monetary Fund (IMF) have approached the central bank and given feedback that this model seems the easiest to implement and other central banks should look into it.

IMF Lending a Helping Hand

As I reported in my previous piece, “Will the World Soon Be Ready for Central Bank Digital Currencies? The IMF Seems to Think So“, the IMF is deeply involved in the development and launch of CBDCs, including by providing technical assistance to many of its members, particularly emerging economies. At the same time, its Bretton Woods partner institution, the World Bank, has been deeply involved in the roll out of digital identity programs across the Global South. According to the IMF’s President Kristalina Georgievan, “an important role for the Fund is to promote exchange of experience and support the interoperability of CBDCs.”

One country where it is doing just that is Nigeria, which was the first largish economy to fully launch a central bank digital currency. But public uptake of the CDBC has been embarrassingly low, with only around 0.1% of the population actively using it. So, the Central Bank of Nigeria has decided to apply a little extra pressure by slashing the daily cash withdrawal limit from ATMs by over 80%. In a desperate bid to boost take up for its CBDC, Nigeria’s central bank is willing to impose widespread economic pain in an economy that is already teetering on the edge.

It is a timely reminder that while digital identity and CBDCs are likely to be rolled out initially on a voluntary basis, it is only a matter of time before more oppressive measures are used to ensure sufficient public “buy-in”. In April 2019, the Mckinsey Global Institute published an in-depth report about digital ID called Digital Identification: A Key to Inclusive Growth. In it, everyone’s favorite consultancy firm noted that fewer than 10% of people had adopted digital ID voluntarily in many of the countries where it has been launched.

This is hardly surprising given the dystopian potential of digital ID systems. Most people in most countries will not voluntarily adopt digital identity or CBDCs, which is why, as with India’s Aadhar system or Nigeria’s eNaira, they will probably be given little in the way of choice. The irony is that central banks’ adoption of CBDCs is, if anything, accelerating even as one of the main justifications for doing so — the growth of private cryptocurrencies, including stable coins – has lost virtually all relevance due to the ongoing crypto winter.

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