For Central Banks, Digital Currency Risks May Outweigh Benefits

A new report released by the Bank for International Settlements (BIS) has found that while distributed ledgers and digital currencies could help improve wholesale securities markets and post-trade processes, the industry will need to cautiously move forward with these rollouts as there are still too many unknown risks. The report, which was issued on March 12 by the Committee on Payments and Markets Infrastructure (CPMI) and the Markets Committee, which are BIS working groups, also notes that the benefits of any such implementation would not vastly differ from those already offered by existing infrastructure.

The findings highlight the need to carry out further research on possible risks and structural changes before any steps are taken toward launching initiatives such as a Central Bank Digital Currency (CBDC), according to the working groups. Wholesale digital currencies combined with the use of distributed-ledger technology (DLT) is believed to have the potential to enhance the settlement of securities and foreign exchange (FX) transactions, but the outcome of the study reflects on the possible risks associated with this uncharted territory and the implementation of a technology that is yet to be fully explored.

In a conference call with journalists on the same day, Markets Committee chair Jacqueline Loh outlined that issuing digital currencies would require “careful and thorough consideration,” and that each central bank must examine their own circumstances and the individual risks that apply to them.

Loh added that although a CBDC could “enrich monetary toolkits, such as strengthening the pass-through of the policy rates to market rates,” it is yet to be deemed superior to any current system in place. Echoing Loh’s statements, the study noted that “more conventional tools and policies can to some extent achieve similar outcomes without introducing any new risks and challenges.”

Another issue relating to CBDCs is the role played by central banks and their influence on the wider economy. Central banks could face significant operational challenges if a digital currency was to replace demand for government securities, shifting the way in which the markets function. An example of this could be an enhanced role of a central bank as a credit intermediary, increasing flows toward the bank in a time of market stress and potentially increasing systemic risk in the process.

Loh stated that there are risks that regulators and central banks are yet to “fully understand” and that each central bank must weigh the “benefits of issuing CBDC against the potential risks.”

In the call, CPMI chair Benoit Cœuré said he believed that every nation should be “mindful of the consequences” of issuing digital currencies and that each country must make a decision based on individual demands and interests, such as monetary sovereignty. Indeed, he continued, existing technologies already deliver “most of the advantages” expected of digital currencies.

Digital currencies have attracted increasing interest over the years, with the Central Bank of Canada and the Monetary Authority of Singapore initiating similar studies on the implications and benefits of digital-currency technology. The research compiled by both institutions supports the need for ongoing exploration into blockchain and DLT to form a better understanding of the potential impact it may have on the financial system and the wider economic landscape.