International Monetary Fund (IMF) director Christine Lagarde has used a speech at the Singapore Fintech Festival to explore the case for state-backed digital currencies. The future role of central banks is uncertain, particularly in an increasingly digital financial landscape.
The subtext of Lagarde’s speech is clear: cryptocurrencies are not the way to go.
Money is changing
Both a cause and an impact of increasing financial digitalisation is that we are moving towards more cashless economies. We live in “a world in which millennials are reinventing how our economy works, phone in hand,” said Lagarde.
Part of that shift is that transactions are taking place in new arenas. People are happy paying with contactless bank cards, negotiating the world of online banking and sending money within their circle of friends and family using external platforms such as Paypal.
A natural step, according to Lagarde, would be for central banks to develop their own digital currencies.
More fundamentally, the case is about change: being open to change, embracing change, shaping change, she said.
Technology will change, and so must we. Lest we remain the last leaf on a dead branch, the others having decided to fly with the wind.
The pros of central bank digital currencies
Lagarde’s speech coincides with the IMF’s release of a paper on the benefits and risks of digital currencies backed by central banks.
In it, the IMF considers the potential for states to supply money to the new digital economy. The result could be that a range of public policy goals are achieved.
Among these goals is financial inclusion. Lagarde said that digital currencies offer great promise in this regard. Smartphones and internet access are prevalent even in poverty-stricken and rural locations – bank accounts are not.
It’s clear that technology has the potential to fill the void, as we’ve seen with early-stage blockchain projects such as London banking startup BABB.
Should digital money really take-off, the inclusion of those left behind by the world of traditional finance is a priority. “If the majority of people adopt digital forms of money, the infrastructure for cash would degrade, leaving those in the periphery behind,” suggests Lagarde.
Lagarde’s second point is that digital currencies backed by central banks could offer more security and consumer protection to users.
Should we move on from paper cash and coins, she explained, the risk is that too much power could fall into the hands of a small number of private payment providers. “Payments, after all, naturally lean toward monopolies—the more people you serve, the cheaper and more useful the service.”
The result could be that these payment providers under-invest in security and serve to undermine the resilience of global banking networks.
“With only a few links in the payment chain, the system may stop working if one of these links breaks. Think about a cyber-attack, a glitch, bankruptcy, or a firm’s withdrawal from the local market,” she said.
Lagarde’s third benefit of state-owned digital currencies is that they are more likely to find the right balance between anonymity and security:
Cash, of course, allows for anonymous payments. We reach for cash to protect our privacy for legitimate reasons: to avoid exposure to hacking and customer profiling, for instance.
But with digital currencies, it’s not so clear how authorities can track payments and the sources of those payments. This is particularly the case with some cryptocurrencies, although some are more anonymous than others.
“Would central banks jump to the rescue and offer a fully anonymous digital currency? Certainly not. Doing so would be a bonanza for criminals.”
All digital currencies face a decision: a tradeoff between privacy and financial integrity. Lagarde’s point is that central banks might be best placed to find the middle ground.
“Central banks might design digital currency so that users’ identities would be authenticated through customer due diligence procedures and transactions recorded. But identities would not be disclosed to third parties or governments unless required by law,” she said.
“Anti-money laundering and terrorist financing controls would nevertheless run in the background. If a suspicion arose it would be possible to lift the veil of anonymity and investigate.”
Finding a middle ground to encourage innovation
Lagarde argued that a healthy central banking system is vital to financial stability around the world.
She also said the popularity of central bank developed digital currencies could actually stifle innovation in the long term.
“If digital currency became too popular, it might ironically stifle innovation. Where is your [startups and fintech innovators] role if the central bank offers a full-service solution, from digital wallet to token, to back-end settlement services?”
Instead, Lagarde suggested that central banks form close partnerships with the private sector. “You interface with the customer, you store their wealth, you offer interest, advice, loans. But when it comes time to transact, we take over.”
“The advantage is clear. Your payment would be immediate, safe, cheap, and potentially semi-anonymous. As you wanted. And central banks would retain a sure footing in payments.
“In addition, they would offer a more level playing field for competition, and a platform for innovation. Meanwhile your bank, or fellow entrepreneurs, would have ensured a friendly user experience based on the latest technologies.”
Internet of Business says
Lagarde’s vision of a future in which central banks create and manage digital currencies is highly probable. There are clear benefits to customers and a number of risks and uncertainties with current efforts in the digital money space.
However, one aspect she failed to touch on in her speech – and one that is arguably a major driver in the push towards digital currency – is apathy towards traditional banking systems.
Following the banking crisis, the subsequent financial crash of 2008 and the ‘fiscal waterboarding‘ of Greece in the years that followed – a mess the IMF was actively a part of – to name just a few recent events, a growing number of people are questioning the status quo and looking for alternatives.
Essentially, cryptocurrency is a libertarian move, away from the perception of reckless banks and toward a financial landscape based on personal independence. One in which individuals have greater control and technology, not banks, is the custodian of transactions, privacy, immutability and security.
Lagarde suggested that digital currencies backed by central banks would offer greater security and consumer protections to customers. The reason being that they would work more closely with regulators and remain in place to build a more resilient worldwide network.
She also made the point that many others have made: that completely anonymous monetary systems – such as cryptocurrencies – open the door to criminal activity: from students buying marijuana online to sophisticated organised crime and money laundering.
But equally you don’t have to look far to find reasons to doubt the financial establishment and its ability to self-police. A few unlucky Icelandic bankers were the only ones to face criminal charges following the crash of 2008.
Europe’s largest bank, HSBC, has paid billions in fines after senior officials were complicit in the money laundering of hundreds of millions of dollars for drug cartels and terrorist groups.
Many of Lagarde’s points ring true. But they also assume that the actions of major banks are properly policed and regulators are empowered to stop practices that damage entire economies and public perception.
Until those fundamental issues are rectified, she can expect the private sector to push ahead with digital currency innovations.