A Foundation of Trust
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- A Foundation of Trust
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Bibliographic details
- Authors: AGUSTIN CARSTENS, JON FROST, HYUN SONG SHIN
- Published: September 1, 2022
Core thesis
- Digital innovation (cryptocurrencies and DeFi) demonstrates technical capabilities—programmability, composability, and tokenization—but has structural flaws that prevent it from serving as the basis for a sound monetary system.
- Central banks should harness crypto’s technical wizardry while providing the core of trust that only central bank money can deliver, via central bank digital currencies (CBDCs) and public infrastructure.
Crypto’s structural flaws (findings)
- Crypto lacks a sound nominal anchor; cryptocurrencies are volatile and stablecoins are not truly stable, as underscored by the implosion of TerraUSD in May 2022 and doubts about the assets backing Tether.
- Crypto induces fragmentation because decentralized designs rely on fees and rents to anonymous validators, causing congestion and exponential fee rises near capacity (example: Ethereum), leading users to migrate to other blockchains and fragment the DeFi landscape.
- Crypto is largely unregulated, with participants not accountable to society, resulting in frequent fraud, theft, and scams that raise market integrity concerns.
- Conclusion: Crypto’s useful technical elements should be adopted but placed on a sounder foundation grounded in central bank trust (BIS 2022).
Central banks as the foundation (analogy and roles)
- Analogy: If the monetary system is a tree, the central bank is the trunk; banks and private providers are the branches; settlement is rooted in the central bank’s balance sheet. Zooming out yields a healthy forest where canopies support cross-border economic integration.
- Central bank core roles:
- Issuers of sovereign currency.
- Providers of payment finality (settlement and irreversibility).
- Safeguarders of payment system integrity through regulation and supervision.
Public infrastructure to achieve the vision (policy instruments and use cases)
- Wholesale CBDCs
- Intended for banks and other trusted institutions.
- Can deliver programmability, composability, and tokenization.
- Example use case: simultaneous tokenized payment and tokenized title transfer for a house, settled by wholesale CBDC as a single transaction.
- Hands-on central bank experiments showcase multiple applications.
- Retail CBDCs and fast payment systems
- Retail CBDCs function as digital cash for households and businesses, with private-sector service providers.
- Central-bank-operated retail fast payment systems provide a common platform ensuring full connectivity of services.
- Promise to lower payment costs and enable financial inclusion.
- Example: Brazil’s Pix system was 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 working on inclusive retail CBDC designs to better serve the unbanked (Carstens and Queen Máxima 2022).
- Cross-border linkages
- Linking wholesale CBDCs across central banks allows banks and payment providers to transact directly in multiple currencies of central bank money using permissioned distributed ledger technology restricted to trusted parties.
- BIS Innovation Hub work with 10 central banks indicates such arrangements can deliver faster, cheaper, and more transparent cross-border payments (Bech and others 2022).
- Potential benefits: lower remittance costs for migrants, greater cross-border e-commerce, and support for complex global value chains.
Policy recommendations and implications
- Adopt technical capabilities demonstrated by crypto (programmability, composability, tokenization) but anchor them in central bank money and public infrastructure to ensure safety, stability, accountability, efficiency, inclusiveness, data control, fraud prevention, adaptability, and cross-border openness.
- Design CBDCs and fast payment systems with the public interest and users’ needs as the guiding principle.
- Use permissioned distributed ledger technology where appropriate to enable trusted, efficient wholesale and cross-border arrangements.
Key statistics and precise facts (preserved)
- TerraUSD imploded in May 2022.
- Brazil’s Pix system was 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 with Pix, one-tenth the cost of a credit card payment.
- BIS Innovation Hub engaged with 10 central banks on cross-border CBDC experiments.
Content based on "A Foundation of Trust" by AGUSTÍN CARSTENS, JON FROST, HYUN SONG SHIN, F&D Magazine, September 2022.
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- A Foundation of Trust