EXPLAINER-Bitcoin’s mainstream charge raises stakes for central bank digital cash

By Tom Wilson

LONDON, Feb 15 (Reuters) – As cryptocurrencies increasinglygo mainstream, pressure is growing on the world’s biggestcentral banks to move forward with their plans to issue digitalcash and fend off private sector threats to traditional money.

The biggest cryptocurrency, bitcoin, has shiftedfrom the fringes of finance towards embrace by major investors,companies and even cities. Tesla Inc’s $1.5 billion bethas sent bitcoin to record highs of almost $50,000 and theFacebook-backed digital currency Diem, formerly known asLibra, aims to launch this year.

Central banks from the Group of Seven nations set out inOctober how a digital currency could function, though progresshas been slow. The communique from last week’s G7 financeministers’ meeting did not mention the nascent technology.

Here’s the latest on central bank digital currencies (CBDC).

WHAT ARE THEY?

CBDCs are the electronic equivalent of cash.

Like banknotes or coins, they would give holders a directclaim on the central bank, leapfrogging commercial banks. Backedby central banks, they would be as “risk-free” as traditionalmoney, and let holders make online payments.

Access to central bank money beyond physical cash has so farbeen restricted to financial institutions. Extending it to thebroader public would have major economic and financialrepercussions.

WHY DO CENTRAL BANKS THINK WE NEED IT?

Central banks fear losing control of the global paymentssystem to cryptocurrencies, which are typically not controlledby any central body – or to private entities, such as in thecase of Diem.

That could weaken central banks’ grip on money supply, oneof the main avenues for steering economies. And the threat hasgrown more real amid the snowballing mainstream embrace ofdigital currencies.

Financial firms BNY Mellon and Mastercard saidlast week they would offer support for digital assets, while thecity of Miami is seeking to allow the use of bitcoin for payingworkers, and for fee and tax payments.

As the use of physical cash declines, a CBDC would be asafer digital payments alternative to cryptocurrencies.

WHAT WOULD A CBDC LOOK LIKE?

Here’s where views differ.

A CBDC could take the form of a token saved on a physicaldevice, like a mobile phone or a pre-paid card, making it easierto transfer offline.

Alternatively, it could exist in accounts managed by anintermediary like a bank, which would help authorities police itand potentially remunerate it with an interest rate.

While the idea of a CBDC was born in part as a response tocryptocurrencies, there’s nothing to say it should useblockchain, the distributed ledger that powers these tokens.

The People’s Bank of China said its digital yuan would notrely on blockchain.

WHICH CENTRAL BANKS ARE LEADING?

The People’s Bank of China aims to become the first majorcentral bank to issue a CBDC, part of its push tointernationalise the yuan and reduce dependence on thedollar-dominated payment system.

State-run Chinese commercial banks are already testing adigital wallet application, local media reports said. E-commercecompany JD.com Inc in December said it wasChina’s first virtual platform to accept the homegrown digitalcurrency.

The European Central Bank and the Bank of England havelaunched consultations, though ECB President Christine Lagardesaid last month any digital euro would take years. The Bank ofJapan and the U.S. Federal Reserve have taken a backseat.

Sweden’s Riksbank has begun testing an e-krona, while theBank of Canada has also accelerated work on its digitalcurrency.

Smaller nations are forging ahead, too: The Bahamas lastyear become the first nation to roll out a CBDCnationwide.

WHAT ARE THE RISKS?

Central banks fear any mass migration to CBDC would hollowout commercial banks, depriving them of a cheap and stablesource of funding like retail deposits.

In a crisis, this would make them vulnerable to a run ontheir coffers as clients would prefer the safety of an accountguaranteed by the central bank.

For this reason, most designs envision a cap on how mucheach consumer would be allowed to hold in CBDC. Remunerationrates might be lower to reduce the attraction.(Reporting by Tom Wilson; Additonal reporting by FrancescoCanepa in FrankfurtEditing by Susan Fenton)