## A Foundation of Trust

## Source details

**Canonical URL:** [A Foundation of Trust](https://www.imf.org/-/media/files/publications/fandd/article/2022/september/carstens.pdf)

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- [Markdown version](/-/media/files/publications/fandd/article/2022/september/carstens.pdf.md)
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### Overview
- Digital innovation is transforming money and payments, with cryptocurrencies and decentralized finance (DeFi) demonstrating new technical capabilities such as programmability, composability, and tokenization.
- The authors argue that these technical capabilities should be harnessed but placed on a foundation of trust provided by central banks.
- "Any legitimate transaction that can be carried out with crypto can be accomplished better with central bank money."

### Crypto’s technical capabilities
- Programmability: the ability to program payments.
- Composability: the ability to combine different operations into one transaction.
- Tokenization: generating a digital representation of money and assets.
- Permissionless distributed ledger technology (blockchain) offers adaptability to new demands and openness across borders.

### Structural flaws of crypto
- Lack of a sound nominal anchor:
  - Cryptocurrencies are not currencies; stablecoins are not stable.
  - Example failures cited: implosion of TerraUSD in May 2022 and doubts about assets backing Tether.
  - Stablecoins "borrow" credibility from sovereign central bank money.
- Fragmentation and scalability constraints:
  - Decentralized incentive structures (anonymous validators, fees, rents) cause congestion and prevent scalability.
  - When the Ethereum network nears its transaction limit, fees rise exponentially, prompting migration to other blockchains and growing DeFi fragmentation.
- Market integrity and accountability issues:
  - Crypto is largely unregulated; participants are not accountable to society.
  - Frequent fraud, theft, and scams raise serious concerns about market integrity.

### Central bank role and rationale
- Central banks provide two key public goods:
  - Issuance of sovereign currency.
  - Means for ultimate finality of payments.
- Central banks ensure smooth functioning of payment systems and safeguard integrity via regulation and supervision of private services.
- Metaphor: central banks are the solid trunk of the monetary system tree; banks and private providers are the branches; the system is rooted in settlement on the central bank’s balance sheet.

### Wholesale CBDCs: capabilities and applications
- Wholesale CBDCs: representation of central bank money for use exclusively by banks and other trusted institutions.
- Technical capabilities enabled: programmability, composability, tokenization.
- Example application: simultaneous tokenized payment and tokenized title transfer for a house purchase, settled as a single transaction on wholesale CBDC rails.
- Use of permissioned distributed ledger technology (restricted to trusted parties) can link wholesale CBDCs across jurisdictions.

### Retail CBDCs and fast payment systems
- Retail CBDCs: digital cash available to households and businesses, with services provided by private companies.
- Retail fast payment systems operated by central banks provide a common platform that keeps services fully connected.
- Potential benefits: lower payment costs and greater financial inclusion.
- Example: Brazil’s Pix
  - Adopted by two-thirds of Brazilian adults in only one year.
  - Merchants pay a fee of just 0.2 percent of a transaction’s value on average, one-tenth the cost of a credit card payment.
- Many central banks are designing inclusive retail CBDC systems to better serve the unbanked.

### Cross-border payments and multiple-CBDC arrangements
- Linking wholesale CBDCs allows banks and payment providers to transact directly in central bank money of multiple currencies.
- BIS Innovation Hub work with 10 central banks shows permissioned DLT arrangements can deliver:
  - Faster cross-border payments.
  - Cheaper cross-border payments.
  - More transparent cross-border payments.
- Potential benefits: lower remittance costs for migrants, expanded cross-border e-commerce, and support for complex global value chains.

### Comparative evaluation: goals for money and payments
- High-level goals listed: 1. Safety and stability; 2. Accountability; 3. Efficiency; 4. Inclusion; 5. User control over data; 6. Integrity; 7. Adaptability; 8. Openness.
- Assessment summary (as presented): Today’s monetary system — policy goal broadly fulfilled but room for improvement; Crypto universe (to date) — not generally fulfilled; Future monetary system (vision) — aims to improve on both.

### Key findings and policy implications
- Crypto demonstrates useful technical innovation but has structural flaws (nominal anchoring, fragmentation, scalability, accountability) that prevent it from being a sound monetary foundation.
- Central bank money should remain the foundation of any monetary system that fully serves society.
- Public infrastructure (wholesale, retail, cross-border) is needed to harness crypto’s technical capabilities safely and in the public interest.
- Private sector innovation should be fostered on a trusted public core, with users’ needs at the forefront and the public interest as the guiding principle.

*Agustín Carstens, Jon Frost, and Hyun Song Shin; Finance & Development, September 2022.*

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_Source: https://www.imf.org/-/media/files/publications/fandd/article/2022/september/carstens.pdf_