Central Banks Wrestle With the Crypto Conundrum

Bitcoins the digital currency everyone's heard of. It's been around since two thousand and nine, but there are now eight thousand other cryptocurrencies out there are competing for your business. That explosion in crypto more than fifteen trillion dollars worth of transactions last year alone. Maybe based on twenty one century innovations like the blockchain, but it feels a lot like the nineteenth century wild West, exciting, uncharted territory, also lawless,

full of snakes. If you don't trust banks or governments, it all sounds great. Central banks and regulators naturally have a rather different response. They want to bring order to the chaos, and they also, many of them, want to compete with digital currencies of their own. At last count, more than a hundred central banks had either introduced a central bank digital currency or had plans to do it.

I got to chair a fascinating discussion of the future of money and central banks at a conference the other day organized by the Bank of International Settlements, the Central Bank of Central Bankers. We had the governor of the first central bank to pilot its own digital cash, the Swedish ricks Bank, the chief executive of one of Europe's biggest banks, and a Yale University professor who's the academic

authority in this area. So if you if you want to actually understand what a central bank digital currency is and why on Earth we might want them, I urge you to carry on listening. But before we talk about the theory, a taste of what a i'fe lived in crypto might be like in practice. Last year, Al Salvador became the first country in the world to make bitcoin legal tender. So Bloomberg Central America based reporter Michael McDonald through his digital wallet in the suitcase and went to

put that to the taste up for me. It's not for me, you know why, because those of us who don't know how to read, we're going to lose money. That was Maria or Billina, who runs a ribbed restaurant in the town of Conchagua, El Salvador, or Billina, is in her late seventies and stands over a pile of meat, waving a butcher's knife as she prepares the day's cuts of beef. She says the learning curve is too steep and swears she'll never accept cryptocurrency as pay men. I

appreciate the visit, but for me, no bitcoin. The government made a mistake with that. Unfortunately they have add advisors. That she's so downbeat on bitcoin is telling because Conchagua happens to be where the Salvadoran government plans to build Bitcoin City, a city free of income and capital gains taxes, and where a nearby volcano will provide electricity for bitcoin minds.

In September of last year, Al Salvador became the first country in the world to make bitcoin legal tender, so the digital currency can be used as an official means of payment for goods and services. It is the biggest test for bitcoin in its twelve year history, and the crypto world has watched closely to see how it all unfolds. It's now February and I am here to test the system.

I jumped in my rent to car for a road trip around the country to see how feasible it is to pay for things like meals, hotels, and even a game of pool using bitcoin. But things don't always go as smoothly as hoped. Infection wasn't completed right now, it's and then when they see that the transpection was committed, that's what happened. That's Natalia Abu lates she manages a local Asian fusion restaurant called Bruto, which opened last year

and accepts bitcoin. My bitcoin transaction isn't processing properly, so I ended up paying with a credit card. In fact, local businesses have reported lots of issues using bitcoin as payment here, from slow internet speed and long delays in transactions to volatile price swings in the digital currency mark. The escoar at National Car Rental in San Salvador tells me the company still needs to upgrade its technology before

accepting it. Right now, our bitcoin app is going through some minor adjustments, so at the moment we are not using it. It's easier to use a credit card because it is easier to charge the deposit and it makes refunding the deposit much easier, Yeah, Ricardo Casta, you know. Salvador based economists for the Central American Institute for Fiscal Studies said the nation's economy is largely made up of small businesses, which has prevented widespread adoption of bitcoin as

legal tender. Large businesses, especially those in the formal sector, high percentage of them are accepting bitcoin. In the case of small business it's a much smaller percentage, especially considering the characteristics of the Salvadoran market, which is largely informal. About seven workers are in the informal sector. So for those businesses, you might find a few that accept bitcoin, but the vast majority don't. If you go to buy

your morning French baguette, they won't be accepting bitcoin. If you go to a PUPUSA, you might find one that accepts it, but the most are not accepting it. There are a few daring entrepreneurs who say bitcoin has been good for business. Oscar Attilio Lopez sells peanuts alongside the highway near a town called Hikualisco, and he accepts bitcoin. Standing outside his tin house with a dirt floor, he said he even pays vendors in the cryptocurrency and has

made three hundred dollars speculating on price wings. I whip out my phone and send him seven dollars worth a bitcoin for two bags of nuts. No, wow, he got my seven dollars immediately. Lopez tells me he made a big sale recently and accepted bitcoin as payment instead of converting it to US dollars. He kept the payment in bitcoin and wound up watching its value rise when he withdrew the money from his checking account. He realized the

thrill of accepting the cryptocurrency. We've never had a problem with it. It's so how fast it was, and that's how fast it's usually is. You can find a few other places that accepted near me. Not every one accepted, but there are a few. The will I got interested to cost the investment aspect called my attention. That's with certain amounts he could make money, according through a price

of bitcoin. Back in San Salvador, Diego Medanda has been speculating on cryptocurrencies for several years and even made enough money on its appreciation against the dollar to expand his small company. He imports jewelry and sells it at several locations around the capitol. Cryptocurrency is the new option. It's

just one more currency. When I was younger, I lived through a new currency when we switched from the clone to the dollar, and this is exactly the same It happened when we only used to use tangible currency, the dollar, and then started to introduce credit and debit cards, and people found it improbable that their money could be on a little plastic thing. It was unthinkable to say I

have ten thousand dollars in my hand. Now we have to convince people that we can say in my phone, I have ten thousand in bitcoin, which is just a new way to implement a new legal currency. So for some in our Salvador, at least, this isn't such a new world after all. And several of the experts I spoke to it that Bank of International Settlements event the other day said much the same thing. The technology may be new, but this debate we're having about what money is,

how we regulated, how we trust it, it's very old. Indeed, you're going to hear an edited version of that conversation now featuring the governor of the Swedish Central Bank, Stephan Ingves, the chief executive of Santander Bank, Jose Antonio Alvarez and the Yale University Professor of Finance, Gary Gorton. Gary, I'm

going to sort of break a precedent. We often start with the policymakers, but I think given the analysis that you've done in this area and the contributions you've made, I think it would be very useful to have you setting a little bit of the landscape that we're seeing that the change in payments around the world. But I think particularly um what challenges and opportunities arise for central banks out of this. So let me let me just

say two things. One is about a hundred years ago or so, every sovereign state decided that the government should have monopoly on the production of money, and the reason was that only the government can provide a currency that trades at par with no questions asked, and only the

government's currency is not subject to bank runs. So the question of whether we should have monopoly, whether states should have monopoly of our money production has arisen again because stable coins are a form of privately produced money, and they've already have a foothold, and I think it's at least in the US, it's too late to do anything

about it until we have the next financial crisis. The other thing I would say, and fortunately I think this is not so controversial as it might have been, but everybody has a seem now the importance of the global financial plumbing was swift, and the U. S. Treasury was using Swift data, you know, before all this to track terrorists and so on. And that's going to change when we moved to blockchain, say in ten years, when everything is interoperable, the standards for how you get data are

going to be completely different. And I think central banks have to be involved here to jointly decide what the standards are going to be and to understand how the data is going to flow. And I think that's an issue that's been overlooked and governor ingvis as. I mentioned that the Risk Bank was very early, I think it was twenty sixteen you announced that you would do that

the pilot of the of the digital currency. How do you think of your role as a central bank in this in this landscape sort of both in terms of your own intervention with the pilot, but also in potentially regulating and moderating the kind of interventional innovation we're seeing on the private space obvious to us, maybe earlier than in some other places, that we needed to sort of start thinking about these things because given the technological change

that was going on, people were just moving out of cash. And then we sort of started thinking about it kind of in a way that Gary just referred to, because we started looking at what happened actually in the late eighteen hundreds, what was the process that produced the division of labor, if I call it that, between the central banks and what the private banks used. But we're doing back then, and the basic starting point is very very simple.

In the old days, everything was on paper. Now we're moving into another world where nothing will be on paper. Now when that technological change happens, would we like to maintain roughly the same structure that has been established for about a hundred hundred and fifty years ago in many many countries, or should we just let it go? And then we came to the conclusion that no, we should not let it go, because that would imply that in my country we would only have private sectre money available

to the general public. And if history gives us any guidance, that's a bad idea, and all the more so in a small, very very open economy where it's important, given that we have our own field currency, that people actually use that currency, because supposed we were just sitting with our arms crossed, the whole thing moves into I don't

know what other other currencies. In that environment, you can forget about monetary policy as we know it, because then there is no way of increasing or reducing the supply own money in the system, because people would start using what I call o PM other people's money, and producing money nowadays in a small central bank is actually a competitive business. People never think about it in that way,

but it actually it actually is. And that means that what we do has to be from a transactions purpose efficient, and we need to ensure that we can maintain the exchange rate between central bank money and private sector money. And if that exchange rate is not one to want, then with a fairly high likelihood, you end up with

serious problems in the system. And those were exactly the problems that we had in the eighteen hundreds when banks issued all sorts of notes and coins on on their own, and that it created all sorts of all sorts of problems. And that has to do with the fact that money is not about technology. Money Essentially, what we have in our heads, and then we need to agree on what we're should have in our heads moving moving forward, and then that speaks in favor of producing a central bank

digital currency. But having said that, I just don't expect a CBDC to sort of outcompete, so to speak, private sector money at all. It's a sort of it's it's the final thing that you can provide on the public sector side in order to ensure that the system is is stabled. We've been around in sixteen sixty and had we not changed the way we do business and the way we do things time and time again, then of course we have been out of this business a long, long, long,

long time ago. And we started out back in the sixteen hundreds with twenty kilo copper coins. That's extremely inefficient, and had we not gotten rid of the copper coins moved into physical notes, then it would have been game over a long long time ago. So now, given that, at least in my corner of the world, people are earlier adapters when it comes to new technologies, and there are probably earlier adapters because there is a fairly good

trust in what the government does. So if you're so if you introduce new technological sort of things into into our system. People tend to use them, and then it's just it's our job to go with the flow. Well, and I guess you have you have to say Sweden was an early adopter when it comes to central banks being being the very first. And of course you've also you were able to solve some of these problems before

for other central banks who came after you. So I guess in the world definitely as you ows you were dead now, Jose Antonio, you are representing all of the private financial system in this debate, so you better be good. But often the private sector view on this is quite different. There is sometimes a feeling, either explicit or beneath the surface, that says central banks aren't the ones who are going to be good at innovating, and they shouldn't be at

the forefront of this development. We should be counting on the private sector to come up with all the right solutions here, Um, how do you see that the comparative advantages of the private and public sector here? The first not you said, doesn't matter where the innovation comes from, as long as the good innovation that it's good for the society as a whole. Doesn't mother it comes from

the central ban of the private sector. I am not going to make a distinction so into between who is innovating whoever it is innovating, welcome, Okay, that's our approach um, particularly in any space where technology has changed. As Stephans before, we've been doing the things in a way for many many years, and suddenly technology allows a more diverse, diverse ecosystem, particularly in the payments space. The payments space has been in space where we used to have the bank's central

banks and a few other places. Suddenly we got on the back of the new technology, the tech companies in the space, the fintech in the space, in a world that where the number of transations grew exponentially on the back of the new technology. Online and e commerce means that the number of transations is growing exponentially year after year. So we have suddenly this and another future that is quite interesting for a lot of business models. That is

the data. So digital payments means that your capacity to gather data that enrich a verety of business models is another feature that came along. Yeah, So with this explosion of the payments using the new technology, volument and I think the public sector has a clear role here. The first thing is we need to establish standards, standards on what on first customer protection, second data security, their data sharing, for privacy, so this kind of things we need to

have standards. So innovation is good, but at the same time, if if we need to have you do an activity, you should have the same roles that other people doing the same activity, the same supervision if any. That has been the role of the on the central banks. So the public sector has a role there. And finally we

have the crypto space. The crypto space I'm not referring to the big coins and like and referring more to the stable coins, digital bonds and all these things, so more kind of traditional means of payments where the shuttle

bunks need to have a potential regulations. If the banks are going to have a financial city desire, going to have these crypto asis in the bounty, we need a well some potential approach in relation with those assets that eventually eventually not there are payment means of payments today carry and I'm sort of interested in you've given the historical parallel, which I suspect some of the sort of the fintech firms would would resent being classed along with

the sort of the wild West years of private currencies in the US. But I think it's quite a powerful parallel. Um. Do you see US regulators sort of coming towards a consistent view on how these stable coins the outside of the central bank system should should be regulated and treated. I don't think they have come to a decision other than that stable coin issuers are banks, and in terms of service of a stable coin, say you can redeem

your coin on demand at par that's a bank. So the Treasury President's working groups said they're a bank, but they didn't say anything else. Really, I think the issuers of stable coins they understand that they have all these problems. They're trying to get some aneer of at ability by getting you know, bank licenses, fintech licenses in various states, but those are not real bank charters and they don't as Mr Alvaret said, there's no prudential oversight of these guys.

So the top five stable coin prices all moved together, right the market can't even distinguish between them. So I think I think eventually we're gonna have to say they're a real bank, and they have to be regulated as a real bank. And I mean this would really come to a head if say JP Morgan issued it's a stable coin, right, that would cause Congress to act right away. But you know then I don't think they're going to

do that. But I mean, I don't want to be too pessimistic, but I think the stable coins are not big now, but they will be big because lots of the problems with blockchain are being solved as we speak.

It's becoming uh scalable. The problem is this interoperability with the current system, and the FED has resisted that they won't give a master account to anybody who looks different than a bank, and that would be one way to get some oversight because you could have rules around you know what you have to do to get a master account. I think the FED on its own could address this, but I don't think they will. I think they want to leave it to Congress. So so I make the

react to this. Yeah, I still having the Museum of the Bank, some builders that were issued by bank or something. They're a hundred and sixty years ago when the bands the rag Bones were issuing their own currency. All of them were preset as supposed to be preset as the currency in Spain at that time, all of them whereas they were goings some cord, whereas they were goings in paper. Yeah. So when this became a monopoly for the reason and Stephan said, and became a monopoly because of the time,

and the reason was much more efficient. Yeah, So it's not about the technology. The technology is there. As long as the technology is all people problems, we should go and using it, but using a reasonable way that allowed to preshare what do you say I wish I should say a public good that is the financial stability. I completely agree with Jose Antonio because as I started out saying,

money is what we have in our heads. Money is a common understanding of what money is as long as we agree on what it is, and that requires some kind of a legal framework, and without a legal framework, you have nothing. So that's where the issue sometimes goes.

In some sense, the way I'm thinking about it a stray because clearly, if you come from the tech side, do you have not spent your days thinking about the legal aspects of what you're doing, And it's the legal framework that defines what kind of a claim you do. You have or do not have. And that's really the issue with with with stable coins because if the legal framework is not there, but the fairly highlight nihood, a stable coin is an unstable coin, and you just don't

know what kind of a claim you ultimately have. And that's not a good thing because if history gives us any guidance, those type of constructions tend to collapse sooner or later. And one one thing we do know is that we human beings, we never learn if it's too good to be true, Well that's the case, and you're not with a problem sooner or later. So if you create something which behaves like a bank, well then go and get yourself a banking license. I'm interested perhaps from

Gary Gorton because of his historical perspective. We have said that there's not always about the technology, and that these issues come up again and again in different forms through history. But I guess one thing that one could say was different about this about the potential of a central bank digital currency would be the degree of information and the degree of knowledge that a central bank could have about its citizens and all the transactions being undertaken by individual citizens.

Against that we have, you know, quite large suspicions around government these days and concern around privacy. Do you think that is one different element to this debate that central banks are going to have to deal with the concern about privacy. Absolutely. I mean there's there's two issues. One issue is the central bank, you know, at least for large transactions, needs to know the identity of those who are transacting, right, And that's that's why swift data is important.

But you can set a threshold and say transactions below this number, you know, we don't care about you just do all that anonymously. And then of course this threshold is going to have to change because you know, if the system is efficient, you can break the big transactions and all these little transactions. So some arrangement about what is going to be anonymous and what is not going to be anonymous is going to be required. But the

central bank has to have credibility in all this. I mean, I think if you even say you know, we're going to have a negative interest rate, people are not gonna want to use it, right, And we saw an Ecuador that their central bank digital currency completely failed because people didn't thrust the central bank. That's absolutely at the core of this. If we have a non central banker talking about belief in central banks. That is a very appropriate

place for a BIS panel to end. Thank you to all of you for an excellent, very high level debate. That's it for this week. We'll be back with more on money and the real economy next week. In the meantime, check out the Bloomberg News website for more on all of the stories featured today, and follow at Economics on Twitter.

This episode was produced by Magnus Henryson, with special thanks to Michael McDonald, Stephan Ingvers, Jose Antonio Alvarez, Gary Gorton, Eugenia Sto Morales, Steve Matthews, and the Bank of International Settlements. Mike Sasso is executive producer of Stephanomics and the head of Bloombow podcast is Francesco Levi.