CBDCs the Core of Future Monetary System: BIS Report

As Terra’s stablecoin implosion and recent market turmoil have demonstrated crypto’s volatility, central bank digital currencies, or CBDCs, offer a more stable solution for a future monetary system, according to the Bank of International Settlements (BIS). 

Crypto’s security risks, high fees and scalability issues, as well as its “unregulated intermediaries that pose financial risks,” are growing concerns in today’s monetary system, BIS said in its annual report, released Tuesday.

“The crypto universe lacks a nominal anchor, which it tries to import, imperfectly, through stablecoins,” the report said. “​​These structural shortcomings are unlikely to be amenable to technical fixes alone. This is because they reflect the inherent limitations of a [decentralized] system built on permissionless blockchains.” 

“The crypto sector provides a glimpse of promising technological possibilities, but it cannot [fulfill] all the high-level goals of a digital monetary system,” it added. 

BIS argues that a future monetary system should contain both the “retail CBDC level” — which is predominantly used by individuals to pay each other or businesses — and “the wholesale CBDC level” — which is used by financial institutions to settle trades in markets.

The monetary system should be built on the division of roles between the central bank and private sector entities, the institution said in its report.

“The metaphor for the future monetary system is that of a tree, whose solid trunk is the central bank,” Hyun Song Shin, BIS’ economic adviser and head of research, said in a statement. “This tree boasts a rich and vibrant ecosystem of private sector service providers serving users to [fulfill] their economic needs. The ecosystem is rooted, figuratively speaking, in settlement on the central bank’s balance sheet.” 

Earlier this month, Israel’s central bank announced a partnership with the Hong Kong Monetary Authority and BIS’ Innovation Hub to test the feasibility of a retail CBDC, Reuters reported. 

China rolled out the pilot for its own CBDC, or eCNY, at the Beijing Winter Olympics in February this year, and Jamaica’s Jam-Dex earlier this month became the world’s first CBDC to be recognized as legal tender — it will officially launch for public use later this month. Several countries, including Kenya, Brazil and Haiti, are also exploring the technology.

“This architecture is assumed to have several benefits: less financial risk for the customer, more liquidity, lower costs, increased competition, and wider access,” the Bank of Israel said.

The BIS said retail CBDCs could play a similarly beneficial role in developing fast payment systems, citing the technical feasibility of a CBDC architecture — also known as Project Hamilton — that can process 1.7 million transactions per second, which is “far more than major card networks or blockchains,” according to the report. 

“These new capabilities not only permit the expansion of the types of transactions, but also enable transactions between a much wider range of financial intermediaries — not just commercial banks. Wholesale CBDCs also work together across borders, through multi-CBDC arrangements involving multiple central banks and currencies,” the report said. 

In another bulletin issued in June, BIS economists said “decentralization proves to be an illusion” and suggested decentralized lending systems would “gravitate towards greater centralization.”

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