This is the first of a three part blog written by Markus Hammer about a digital Franc for Switzerland. This first part describes why states and their central banks are currently pushing their CBDC (Central Bank Digital Currency) with great momentum, the relation to private cryptocurrencies like Bitcoin and why the latter are not like money. Part 2 then presents CBDC as a digital state currency with its potential benefits and threads, followed by Part 3: A Swiss e-Franc based on a SNB design of March 2021 and its preserving versus disruptive character.
WHY ARE CENTRAL BANKS INCL. SNB PUSHING FOR A CBDC?
These times, a lot is being written about Central Bank Digital Currency ("CBDC") and the push of central banks to introduce a digital currency next to the existing traditional national currencies. Primarily, forms of digital cash are at issue. The U.S. Fed, the ECB, the Chinese central bank, others more, and also SNB (Swiss National Bank) are already testing such digital currency or considering it. The excitement is justified given its potential wide-scale implications as the money of the 21th Century onto monetary policy, financial stability, the financial service industry as a whole and customer privacy. Theoretically, a CBDC has the potential to disrupt the entire financial system as it is known today. A closer look at the topic makes clear that CBDC is not CBDC, though; state money cryptocurrency models can vary country by country quite significantly. This article focuses on the Swiss CBDC model proposed and currently been tested by SNB within its project "Helvetia". The model for a Swiss e-Franc is put into context to Distributed Ledger Technology ("DLT")-based cryptocurrencies, the function of state and private money, its governance between public and private sector and explains by how far such Swiss model is designed to disrupt the current and well established system to the better or the worse.
First, let me give an explanation where this sudden push of central banks for CBDCs might come from. First and foremost it needs to be seen in the most recent development, actually a real hype, of crypto currencies as Bitcoin, Ether and alike. With the recent record highs of Bitcoin, to name just the most established crypto currency in the market, hitting the $60k mark rocketing from only $20k mid December 2020 and currently settling somewhere between $50-60k, private cryptocurrencies compete more and more with national currencies, the most recent example being Big Techs entering the market with stable coins like Diem (formerly Libra). Market value of cryptocurrencies have grown to more than $1 trillion in 2021. The reason for such rise are manifold from the expectation to use it as a means of exchange over (speculative) investment or safe haven considerations outside the existing financial system and due to growing distrust into national currencies as a result of continued expansionary monetary policy world wide including quantitative easing. Investors, be it retail or institutional ones, see Bitcoin & co. more and more as an alternative investment to diversify their portfolio, and observing selective companies like Tesla or PayPal, accepting Bitcoin or making respective announcements for the future. But also national currencies are in severe competition with each other, e.g. The Chinese central bank with its ambition to subsidize the US Dollar rather sooner than later as the globally leading currency and therefore enforcing their plans to introduce their CBDC into the market soon. Next to these reasons, concerns are risen also about less obvious objectives of central banks to facilitate direct access into the user's pockets or digital wallets by introducing a state-governed digital currency. Technically, such scenario could be possible depending on the CBDC model chosen, would be highly disruptive and indeed impose a worrying thread to the current system and its users. I'll outline further down, if the proposed digital Franc by the SNB is meant to be of such disruptive nature or just adding digital features whilst leaving the existing governance as is. But even if an e-Frank model would be disruptive, the current legal system in Switzerland would presumably not allow it as opposed to both, the constitutionally guaranteed freedom of property (and for companies the economic freedom) on one hand and the customer transaction privacy regulations on the other hand.
WHAT IS BITCOIN AS A CRYPTOCURRENCY AND WHY IS IT NOT LIKE MONEY?
Bitcoin's ambition and its benefits
Bitcoin was introduced in 2009 based on Satoshi Nakamoto's white paper to be the first cryptocurrency operated via Blockchain. Its original idea was to establish a new financial system, public i.e. open to everybody and fully decentralized, i.e. without intermediaries like banks or centralized counterparties like authorities. Bitcoin is run on a blockchain technology, which is a specific type of a DLT infrastructure and offers different features. The Bitcoin blockchain is a decentralized peer-to-peer network distributed physically and geographically on numerous databases. It is fully transparent as balances are kept on a public ledger that everyone has access to and are tamper-proof due to its highly secure consensus-finding processes based on cryptographic algorithms (referred to as the proof of work). Hence, transactions once executed cannot be changed but in the same time they can be verified and tracked back to its origin. As peer-to-peer network it is highly available and due to its redundancy (every blockchain is stored locally on every blockchain user's computer) safe from attacks or physical interference. These great advantages lay out a foundation with the potential to emancipate from existing financial systems, which are heavily regulated, controlled by central banks and costly operated by commercial banks and other intermediators, one could imagine; the trust problem into human nature, which has to be mitigated in the known alternative systems via intermediaries can be eliminated right away with a blockchain-technology, and within such dis-intermediated financial system literally everybody could even act as their own bank. From that original idealistic vision, Bitcoin has meanwhile moved away; instead of running their own nodes and mine Bitcoins privately as at the beginning, users meanwhile prefer convenience and buy their Bitcoins simply via new intermediaries emerging but more or less offering comparable services like easy purchase, secure custody, smart apps and more. Nevertheless, Bitcoin is the first mover for cryptocurrency which is reflected also in its by far strongest market capitalization compared to other digital currencies, e.g. Ether & co. and in the fact that its model served as an initial blueprint for the meanwhile over 3'000 other cryptocurrencies in the market.
These undisputed benefits yet come to a price. The strong decentralization can only be achieved at the cost of efficiency, and there are different aspects to it: Probably the most relevant scalability-aspect is the limitation of the (Bitcoin) blockchain to process only 7 transactions per second, compared e.g. to the credit card business as a benchmark with 10'000 transactions per second. For a technology made to function as a currency, this is a real obstacle. Further inefficiencies are an effect of the tamper proof-feature which requires every blockchain to be stored on every node and with it additional storage space need as the transaction chain grows over time. As an additional inefficiency with growing relevance in times of global warming and calls for ecologically sustainable solutions, significant amount of energy is required to support the consensus mechanism feature for validating the data between the nodes. Even though, there has been significant progress since the deployment of the Bitcoin blockchain with other DLT-based cryptocurrency networks to increase efficiency, scalability will remain a problem compared to alternative, more centralized or private networks and technologies.
A last downside aspect of Bitcoin is its high price volatility. Such property might be useful to serve as a speculative investment object, but Bitcoin's primary purpose is to function as a currency. A means of exchange, a stable price is essential.
What are the features traditionally attributed to money ...?
In the recent months, the Bitcoin price has been rising at astronomical heights, but what makes people and investors believe in it? It is barely just an abstract idea to emancipate from the existing centralized and regulated financial system? Is it the hope to serve once as a means of currency which can be used at every corner to make payments? Or is it the users consider Bitcoin more and more as an investment with an inherent real value like an asset? In that case, what could make such a value of Bitcoin? Isn't a Bitcoin anything more than a number stored on a technically secured digital ledger? In fact, Bitcoin as a value carrier can bee looked at as a currency and as an asset. As a currency, it would ultimately be a form of money and as an asset a form of an alternative investment object, e.g. similar to gold. Let's take a closer look at both aspects of Bitcoin.
Money is generally described as an asset which can be used to purchase goods and services, meaning it must be commonly accepted as a medium of exchange. It must not necessarily also being a store of a value; equities, real estate or mentioned gold do so as well. In our everyday use we distinguish between state money, issued as a monopoly exclusively by the central bank, a state's agent, as a legal tender in form of cash (physical banknotes and coins) and private money issued by commercial banks as a liability to and accessed by the customer via checks, debit or credit cards and bank transfers. Commercial banks guarantee convertibility of its private money at a fixed price at par to central bank money, hence this form of private money is pegged to the state money. State money does not carry an intrinsic value anymore and since the system of a gold-backed money under Bretton Woods was abandoned in 1971 and why it is called fiat money / currency. Yet, fiat money can be attributed a value in the sense that it is been recognized as a legal tender and through its price stability, achieved if the central bank fulfills its mandate to maintain price stability properly and independently and thereby trust is granted into the national money. In the end, the users can rely on a stable value of the money on their (electronic) bank account, can comfortably and reliably access it and therefore trust into the (regulated) financial system as a whole.
... and why does Bitcoin as a cryptocurrency differ from traditional money?
Comparing the properties of traditional money with Bitcoin as private digital money, there are relevant differences.
Firstly, Bitcoins are not commonly accepted as a medium of exchange. Bitcoin is generally not accepted as a payment to the widest extend, neither for private liabilities (even though some companies start to open up for it) nor depths to the state, e.g. taxes (exceptions build the rule also here, e.g. The Swiss canton Zug as the home of crypto valley accepting Bitcoins meanwhile to pay taxes). Further, Bitcoin is commonly not accepted by commercial banks to be booked on their client's accounts, unless the bank would buy and sell it themselves via crypto exchanges on behalf of their banking clients and after they have properly identified them via know your client ("KYC") procedures based on the related anti money laundering ("AML") financial market regulation. One of the main reasons for its lacking acceptability, obviously, is its high price volatility. Unlike traditional money as a legal tender, and generating its price stability through its proper management by the central bank, Bitcoin's price is not stable, hence and next to its technical limitations not made to serve as money in its proper sense. There are meanwhile new types of cryptocurrencies in the market which tackle this weakness by using so called stablecoins, the most prominent example probably being the Big Tech money Libra, recently re-labelled to Diem. Diem is using asset-backed stablecoins which are even redeemable by authorized participants and, thereby, are much closer to traditional money as cryptocurrencies like Bitcoin (though, it remains to be seen, if they can compete with CBDCs). With these weaknesses, Bitcoin will remain outside of the traditional financial system at least for the time being and as long as unregulated - one can only use it as a private crypto money within the admittedly fast growing Bitcoin community and ecosystem.
Second, Bitcoin is missing an intrinsic value like fiat currency. Nobody can say what its real value is or should be. Assets have an inner or intrinsic value and are, thus, naturally also made to serve as an investment object. In contrast, there is no such value of Bitcoin - it is just a number on a digital ledger. At this point, cryptocurrency evangelists often refer to Bitcoin as the digital new gold. However, this comparison is at least partially flawed. It is true that Bitcoin, like gold, is a limited resource; there are maximum 21 million Bitcoins available latest by 2040 when even the last ones are mined. Such limitation of an asset can attribute something like a value. Generally, both also serve as a currency. Ultimately, however, a bitcoin remains a piece of code, whereas gold still has an intrinsic value, e.g. use as jewellery or an industrial commodity. In addition, gold has had to earn its value as the oldest and most constant means of payment over a history of more than 2500 years, if one likes to accept the idea that it was the legendary king Croesus of the Lydians who, back in 560 BC, has decided to turn gold into money
As a consequence, Bitcoin technically cannot be considered as a currency, neither as an asset; missing are the general acceptability as a medium of exchange, the price stability of a currency and its intrinsic value.
End of part 1 of the series "Digital Franc for Switzerland; is there reason to worry?". In part 2, Markus Hammer explains what a CBDC as a digital state currency is, and its potential benefits and threads.