February 20, 2021

ONAnyone who bought Bitcoin a year ago needs to feel validated – and rich. The price of the cryptocurrency topped $ 50,000 for the first time on February 16, a five-fold increase from last year. Wall Street giants like BlackRock, Bank of New York Mellon and Morgan Stanley are considering whether to keep some for customers. Last week, Tesla, an electric car maker, said it bought $ 1.5 billion worth of Bitcoin and would accept it as payment for its cars.

Listen to this story

Your browser doesn’t support this

Enjoy more audio and podcasts on iOS or Android.

Investor interest in Bitcoin as an asset may increase, but the inefficiencies and transaction costs associated with using it make it unlikely that it will ever be a sustainable currency. Here was the action within the central banks. As consumers turned away from the use of physical cash and private companies like Facebook showed an interest in launching their own tokens, many central banks have started issuing their own digital currencies. The Bank for International Settlements, a club of central banks, expected last month that a fifth of the world’s population will have access to a central bank digital currency (CBDC) by 2024.

China is the clear leader. On February 17, it completed the third major test of its digital currency and distributed 10 million yuan ($ 1.5 million) to 50,000 shoppers in Beijing. It announced a joint venture with SWIFT, an interbank messaging system for cross-border payments. Sweden, another champion, has expanded its pilot project.

The European Central Bank (ECB) is the youngest major central bank to take a serious look at a CBDC. The public consultation asking for comments on the desirable features of CBDCs closed in January and received over 8,000 responses. Christine Lagarde, its president, told The Economist on February 10 that she was planning to seek approval from her colleagues in order to prepare for a digital euro. A decision is expected in April. Ms. Lagarde hopes the currency will go online by 2025.

Much like other central banks, the ECB wants to offer consumers digital tenders that are as secure as physical cash. In contrast to bank deposits, a claim to central bank reserves does not involve any credit risk. Transactions in digital currency could be settled instantly in the central bank’s ledger instead of using lines from card networks and banks. This could act as a backup system in the event that failures or cyber attacks lead to private payment channels failing.

The bank also sees a digital currency as a potential tool to strengthen the international role of the euro, which only accounts for 20% of central bank reserves worldwide, versus 60% of the dollar. Foreigners could use central bank money to conduct cross-border transactions directly, which would be faster, cheaper and safer than routing them through a network of “correspondent banks”. That could make the digital euro attractive for companies and investors.

The main attraction could be offering a level of privacy that neither America nor China can promise, says Dave Birch, a fintech expert. The former uses its financial system to enforce sanctions. The latter seeks control. However, it will be difficult to find the right design: the European Union wants to continue to be able to track cash that is laundered or hidden to evade taxes. One solution could be for users to only open e-wallets if they have been verified by banks, but the use of the digital currency itself is not monitored.

A hugely successful digital euro could withdraw deposits from banks and jeopardize the availability of credit. Remedial measures considered include limiting the number of currency users or, as Fabio Panetta, a member of the ECB’s Executive Board, suggested on February 10, imposing penalties for use above a threshold. A digital euro could also involve an “enormous legal reform”, says Huw van Steenis from UBS bank. The “finality of settlement”, which regulates when a payment is completed and cannot be reversed, varies in the 19 countries of the euro area and should be harmonized. Starting a CBDC requires more than just token effort.

The full interview with Christine Lagarde can be found at Economist.com/CLpod

This article appeared in the Finance & Economics section of the print edition under the heading “Token Gestures”.