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While the future is unknown, it appears that digital currencies will dominate both money and payments. The advantages of ease, cheaper costs, and the prospect of broader financial inclusion are compelling. However, one issue that has received insufficient attention is the possibility for increasing monetary instability. And it has nothing to do with the erratic nature of bitcoin prices. While problems in different stablecoin designs have already been identified, the fragility issue extends beyond these and may harm central bank digital currencies (CBDC) as well.
Today, money is rather decentralised, with the majority of money production split between a number of commercial institutions. Despite blockchain decentralisation, there will be significantly fewer CBDCs and stablecoins in a digital currency future. The issue of being too big to fail will become much more acute.
A second source of fragility is that most existing systems segregate money balances and payment infrastructures, making the ecosystem more robust. As a result, they are more resistant to previously unknown cryptographic vulnerabilities or software problems. The payment message and the money are combined in tokenized digital currency systems. That crucial advantage is also a flaw, a possibly deadly one.
Other sources of fragility have been discussed elsewhere and are not the subject of this article. These include the dangers associated with algorithmic stablecoins or those backed by high-risk assets. And the strain on treasury and money markets if there is a run on a massive stablecoin.
The goal is not to reject digital currency, but to explore whether we can harness its benefits without undermining the foundations of money. This article focuses on two elements of fragility, with potential remedies addressed in a subsequent article.
Fewer too-big-to-fail infrastructures
While the graph of European banks below shows a vast number of banks, many of us are aware of considerably fewer truly large banks in each nation. In a future with stablecoins and CBDCs, there will most certainly be one or two large US dollar stablecoins and maybe a CBDC, as well as a CBDC for the Euro across all eurozone countries.
If you imagine six large banks in each of the eurozone’s 19 nations, that’s 114 huge banks, versus a future with possibly three major eurozone digital currencies throughout the entire block, including a CBDC. In the United States, we think of well-known banks like JP Morgan, Bank of America, Wells Fargo, and Citigroup. These four megabanks control (*an exaggeration) 52 percent of the $21.1 trillion (March 21) commercial banking assets in the United States, with the remainder distributed over the 5,177 FDIC-insured banks. That takes a lot of focus. However, in a world of digital currencies, it will be considerably higher.
This concentration is already visible in stablecoins, with two leading dollar coins, Tether and USDC. They account for 78 percent of dollar stablecoins, with assets of $62 billion and $25 billion, respectively.
Consider a run on one of the major banks in a developed country. Consider how that would look with a slew of transnational digital currencies.
Consider one way that the possibility for runs is presently being addressed: by restricting access to high-value payment systems. In a world of tokenized digital currencies, however, the money and the payment mechanism are one and the same.
Current infrastructures separate payments from money balances
Most payment systems today, whether they are SWIFT for cross-border payments or local payment systems, are messaging platforms. The money is held in commercial banks or in commercial bank balances at central banks.
SWIFT-related hacks have occurred, however they have typically compromised a specific bank’s SWIFT credentials. A notorious recent example is the 2016 $81 million Bangladesh Bank heist.
As in the case of Bangladesh, a cyberattack on a payment system might have an impact on a few big payments that have gone wrong. Payments made through that system may be momentarily suspended before being resumed.
The greater danger, though, is a software fault or cryptographic weakness discovered in widely used software, as has occurred numerous times in the previous decade, with the HeartBleed issue discovered in 2014.
In a world of digital currencies, the payment mechanism and the currency are synonymous. As a result, a successful hack or code error may have a major impact on currency holdings or, more likely, damage trust in that currency, prompting a run.
While many central bank papers emphasize the importance of cybersecurity, this is far more than a tickbox to-do list item.
Singapore Senior Minister Tharman Shanmugaratnam, who leads the Monetary Authority of Singapore, is one politician who has openly acknowledged the dangers (MAS). Speaking about cyber problems earlier this year, he stated that it is “one of the reasons why I myself favour this biodiversity.” And I am opposed to having a single dominating central bank digital currency solution, even within our own countries, let alone internationally.”
“You don’t want the whole system blowing up at once,” he said.
* If investment banking statistics were removed, the real proportion would be lower. The entire assets of the main four banks (including investment banking assets) were compared to overall commercial banking data from the Federal Reserve.
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