"Economics is everywhere, and understanding economics can help you make better decisions and lead a happier life."
-- Tyler Cowen
Welcome to the Economic Surplus, the newsletter brought to you by the Marshall Society! We are the University of Cambridge's flagship economics society. Every week, we bring you our bespoke commentary on economic trends, updates on our exclusive members' events as well as a summary of the headlines you can't ignore! You've probably received this email because you were previously subscribed to the Marshall Society's old email list, but if you have been forwarded this by a friend, feel free to subscribe here!
This week’s Marshall’s Thoughts are written by Edric Wong.
The recent crash of FTX and the surrounding controversy have led to serious scepticism about the integrity of cryptocurrency platforms and cryptocurrencies themselves. Introduced as a financial revolution, the notion of a distributed ledger, which underwrites cryptocurrencies, was promised to streamline transactions and render banks or intermediaries redundant. But as the “Crypto Winter” stretches, without an end in sight, investors and regulators are increasingly critical of the supposed potential for cryptocurrencies to transform the world of finance and banking. At the same time, however, central bankers around the world are considering or introducing their own central bank digital currencies (CBDCs) and utilising blockchains in their development of CBDCs. Before these currencies become widely used and accepted, it is important to study how CBDCs differ from cryptocurrencies that are available in the market, as well as the factors that motivate or deter the development of CBDCs.
The common decentralised cryptocurrencies in the market, such as Bitcoin, uses a distributed ledger, such as Blockchain, to secure their transactions. Instead of having one centralised system that keeps track of all transaction data, a distributed ledger relies on a shared and synchronised database, such that every token contributes to the integrity of the entire system. Whereas banks traditionally play the role of a centralised administrator—they retain a record of transactions and guarantee its authenticity—all transactions in a cryptocurrency are recorded in the currency itself, and fraud is prevented not by appeals to authority, but by a collective record-keeping system. As a result, a distributed ledger avoids a single point of failure, such as the bank, in the system by removing the need for mediators.
On the other hand, although discussions of CBDCs are often lumped with those around cryptocurrencies, the two are not necessarily related and are only similar in the sense of their novelty. The idea of having a digital currency is not new, as many banks have turned towards online digital banking, through which clients can easily transfer money to others. In fact, over 97% of money circulated today is done online through online transfers and online banking. However, the developments in cryptographical technologies have enabled the use of blockchain in issuing currencies. Unlike Bitcoin, CBDCs will still be issued and managed by the state, and they will act as a government backed digital currency, which is used by consumers and businesses as how printed money is used. At the same time, the introduction of blockchain enables specific features that are unique to CBDCs and impossible for paper or non-blockchain digital currencies.
With the introduction of a blockchain-based CBDC, governments face serious choices in their designs of CBDCs, as they must balance many concerns from stakeholders such as traditional banks, private companies and citizens who will be using the currency. These concerns affect how a CBDC is designed, such as whether certain information is encrypted or anonymised, whether government officials can access the information, and whether central banks should be directly issuing the currency. At the same time, in countries with more mature private electronic payment systems, existing infrastructure may be more readily adapted or may predispose the setup of CBDCs.
First, one of the main reasons for introducing CBDCs is to combat the risk of overdependence on the other cryptocurrencies, which results in an increase of government power. Although cryptocurrency is still in its early stages, the potential for this method of payment to become universal seems probable in the future. For example, in a future world, where Bitcoin becomes a dominant medium of exchange, consumers use bitcoins to buy goods and services, and firms use Bitcoins for factor payments. In this theoretical world, Bitcoin will pose a huge threat on the government’s ability to manage their own economies and they can no longer influence the monetary policies. As cryptocurrencies are decentralised and are independent from any single central bank and government, this means the Central bank will lose their power over the economy. Furthermore, this destabilises the economy, as evident from the volatility and crashes in the cryptocurrency markets. To retain the control over the issuance of currency and keep hold of the Central banks power to implement monetary policies, the introduction of the CBDC will allow the digital currencies to go through the Central banking system. The development in E-Yuen in China serves an example of countering the market power of private companies, as large tech giants in China have been moving towards financial technologies and the government is getting wary of the move. Alipay and Wechat account for nearly 94% of all online transactions in China, and their ambitions have more recently received stricter scrutiny—as seen from the blocking of the Ant Group IPO.
Secondly, CBDCs could minimise the risks in banking and prevent future bank runs by also expanding the involvement of government as an issuer of credit. Just like how our paper money originated as IOUs, in which the value of the paper money is grounded by a belief in its convertibility to gold, the digital money issued by commercial banks is also derived from a belief in its convertibility to paper money. The number in your bank account has no inherent value other than the belief that it could be converted to paper money on demand. So, when the depositors lose the confidence that the bank could convert the digital currency to paper money, this will lead to a bank run. However, because CBDCs are issued and guaranteed by a central bank, it is a sovereign credit and is backed by the government’s ability to tax. Therefore, the risk is spread out over the entire population, instead of being borne by the depositors of an individual bank.
Furthermore, a CBDC will allow easier implementation of policies and monitoring of the economy. As the CBDC uses a centralised system which processes and records all transactions, the government has better real-time information of the state of its national economy. The vast amounts of transaction data recorded in a central system could reduce the inaccuracies or inefficiencies of individual reports from commercial banks or other economic indicators. The perfect information regarding purchasing habits and reactions to policies could also generate useful data for research and future policy guidance. Moreover, the ability of Central banks to directly affect consumer interest rates could also make it easier for the government to manage the economy and influence the state of the economy.
As explained above, the benefits of CBDCs are closely connected with the role of government oversight and involvement in the economy. This raises the question of privacy and limits to governmental power. When governments weigh the benefits of CBDCs and adopt particular designs, they should consider the acceptability by relevant stakeholders, as well as the legal and political limits to their power. At the same time, it is important to consider the role of private market actors in this domain. Big tech companies have intimate knowledge of our online presences and constantly package and commercialise personal data. As we consider the possibility of CBDCs and their potentials and concerns, we should have a comprehensive discussion about the role of government and private actors in structuring our daily economic activities.
In Case You Missed It:
Rail reform needed before workers' pay increases, says transport secretary: https://www.bbc.co.uk/news/uk-politics-63773083
Cost of living crisis to last until 2023, Bank governor warns: https://www.thetimes.co.uk/article/britons-facing-biggest-drop-in-living-standards-ttw2rnnf5?gclid=Cj0KCQiAsoycBhC6ARIsAPPbeLvcF5n8ep2y0G9NJaCbc-5oD3fzBkz2DpHhb-vWR_GYLPZPOb-axJwaAsQZEALw_wcB
Unrest breaks out across China, as frustration at lockdowns grows: https://www.economist.com/china/2022/11/27/unrest-breaks-out-across-china-as-frustration-at-lockdowns-grows
Expensive energy is baked into Britain’s future: https://www.economist.com/britain/2022/01/15/expensive-energy-is-baked-into-britains-future?utm_medium=cpc.adword.pd&utm_source=google&ppccampaignID=18156330227&ppcadID=&utm_campaign=a.22brand_pmax&utm_content=conversion.direct-response.anonymous&gclid=Cj0KCQiAsoycBhC6ARIsAPPbeLt8A0RnFktM-fmulTSFJvbD6FIbHTBjVSmgGve9ssShDoZeAqBkIqAaAlRFEALw_wcB&gclsrc=aw.ds
That's it from us for now!
The Marshall Society