After Tether: Designing Central Bank Digital Currencies

Unless you’ve been hiding under a rock, you probably heard about the hack allegedly suffered by Tether this past Monday. Suffice to say, the situation is complex (losing approximately $31 million will have that effect), and the ties between Tether and Bitfinex may have implications for the entire bitcoin ecosystem. Instead of discussing this case, I’d like to lay the groundwork for discussion of central bank digital currencies. Against the backdrop of the decentralized dream, I will highlight the incompatible motives of private blockchain companies promoting digitized national currencies. Furthermore, I will argue that central bank oversight of digital currency is preferable and necessary.

In most (if not all) nations, central banks issue currency and implement monetary policy. Central banks maintain control of the money supply and set interest rates on loans and bonds, among other duties. They function as the bedrock of the modern international financial system. In the United States, for example, the Federal Reserve (Fed) undertakes open market operations – the buying and selling of government securities – to vary the amount of money in the banking system. The Fed also sets reserve requirements for member banks and functions as a lender of last resort, in addition to other responsibilities.

The interdependent roles of a central bank demand tight control. If the Fed didn’t control the money supply, then it would be pretty difficult to control interest rates or stimulate economic activity. It would be like driving a car while somebody else controlled the pedals. As noted today by a senior official from the Bank of Japan, digital currency seems to be a ways off.

But that has not stopped private companies from pursuing blockchain-based equivalents of national currencies.

The challenge is that companies are usually profit-driven. They’re not working in the interest of national financial stability. There’s no guarantee that they’re even working in the best interests of the consumer (or citizen).

The greatest concern about these private digital currency equivalents is that there is fundamentally no oversight from the countries whose currencies are being digitized. Did the Fed secretly sign off on a blockchain-based version of the dollar coming out of Hong Kong? I don’t think so.

As a private company swaps digital tokens for tangible state-issued dollars, euros, and yen, where is the proof that the fiat currency is being kept in reserve? After all, nothing requires the company to swap the tokens back for fiat currency. This is essentially creating money out of thin air. It’s completely manufactured. Maybe one could argue that a central bank operates in the same way – but the difference is the profit motive.

When a company digitizes a dollar (or any other national currency), there needs to be evidence that the fiat currency has been locked up – or perhaps, destroyed. Otherwise, we might have a world where the money supply is just doubling through a corporate avenue. What’s to prevent the company from spending these actual currencies? If we could all just print money, then we’d be run down by uncontrollable inflation. It’s completely nonsensical.

One of the most concerning aspects regarding private issuance of national currency equivalents is the ability to censor specific individuals or groups. If a company can freeze a person out of the financial system, we risk the very censorship that decentralization is supposed to solve.

So far, it’s not even obvious that the cryptocurrency community has achieved network effects for its assets. As central bankers consider digitizing national currencies, it’s important that they retain control of issuance mechanisms and operate apolitically.