Hello, friends,
As long as the internet has been around, people have been asking why we can send messages over the wires but not digital money.
The reason used to be simple: It was too easy to replicate digital money. But cryptography changed that—mostly—with methods that allowed for verification that a digital asset had only been spent once.
However, cryptocurrency still hasn’t taken off. After a two-year period of soaring valuations, the cryptocurrency market collapsed this year and is down nearly $2 trillion from its peak in November. The wealthy owners of many crypto operations have survived intact, but retail investors have suffered.
There’s another way that a digital currency could play out, though. Rather than being a renegade asset not backed by any government—and carrying all the risks that come along with that—it could just be another form of money issued by a central bank.
And many central banks are working on doing just that. Bankers don’t attract as much attention as flamboyant crypto entrepreneurs, but many of them have been quietly toiling away at projects that would keep the good parts and jettison the bad parts of cryptocurrencies. According to the Atlantic Council, 105 nations are exploring digital currencies.
Earlier this year, President Joe Biden signed an executive order laying out a national policy for digital assets, the House Financial Services Committee held a hearing on digital currencies, and the Federal Reserve commenced a study on how to develop a digital currency.
To understand the landscape of digital currencies, I spoke with Neha Narula, director of the Digital Currency Initiative at MIT Media Lab. She is a member of the World Economic Forum’s Global Future Councils on Blockchain and has given a TED talk on the future of money. Narula is working with the Boston Federal Reserve Bank on a project that explores the scalability, speed, and resilience of a central bank digital currency.
Our conversation, edited for brevity and clarity, is below.
Angwin: What is a central bank digital currency, or CBDC ?
Narula: These words are in flux and being defined as we go, but a central bank digital currency is defined as a digital form of central bank liability.
There are two existing forms of central bank liability: cash, like the dollar bills in your pocket, and central bank reserves, which only approved institutions can access and hold. CBDC is another form of central bank liability that is digital, unlike cash, but also generally available to the public, unlike central bank reserves. It’s a digital liability of the central bank that’s available to the public.
Right now four CBDCs have launched. There’s the eNaira from Nigeria and the Sand Dollar in the Bahamas. The Eastern Caribbean Central Bank has also launched one, and Jamaica is the newest country doing a phased rollout. Then there is China’s e-CNY, which has not officially launched but is in late-stage pilots.
Angwin: Can you tell me how these currencies compare to cryptocurrencies, which is what I think most people think about when they hear “digital currency”?
Narula: The most important word is right in the name: central. Cryptocurrencies are designed to not require a centralized actor. To provide a bit more history, people have been talking about digital cash and e-cash for decades. During the ’80s and ’90s, when people were thinking about using cryptography to protect information and keep information secret, they were also thinking about digital cash. A question of interest was whether we could use cryptography to create digital cash, because the problem with digital cash is that it’s digital—it’s bits, and bits are normally really easy to copy.
The digital cash systems before cryptocurrency required a centralized actor to keep track of what coins had been spent and make sure that the same coin couldn’t be incorrectly spent multiple times. There were some really cool designs that provided privacy and other types of functionality, but they never really took off.
Fast-forward to 2008 when Satoshi Nakamoto came up with this novel idea: Instead of requiring a centralized entity to run the ledger and keep track of what coins have been spent, let’s distribute that functionality in a network, and let’s make that network permissionless, meaning that you don’t have to ask permission of the people already in the network running the ledger to join. That was the novel insight Satoshi came up with through bitcoin. Bitcoin pulls together a lot of ideas from digital cash systems of the past, but it does so in a way that doesn’t rely on a single entity or small group of entities to run the ledger. Following bitcoin, we saw a huge amount of innovation in the cryptocurrency space.
Angwin: What do you think has been learned from the recent crypto crash? Has it changed your views at all on digital currency?
Narula: The lesson for me from the crypto crash, interestingly enough, was sort of that everything happened the way it should have. There were many actors who were taking risks that would not go well if the price went down, and there were a lot of designs that were not well thought out or designed to withstand shocks. There were people being irresponsible, and at least some of those irresponsible people had repercussions for their actions, which seems reasonable. It seems like the world is working the way it should be.
I think where things become more concerning is considering the retail public, who were affected by the actions of these irresponsible people. I want to be clear, I don’t think bailing out the crypto industry is likely or necessary. Centralized intermediaries took risks—and when the price crashed, certain things happened that caused those risks to come to light, and they should be in bankruptcy proceedings. What’s unfortunate is all the people who bought assets or trusted their assets with these intermediaries, not really knowing all the details. At the same time, we’ve been pretty clear that these are risky assets.
Angwin: When and why did central banks become interested in digital currency?
Narula: During all of the cryptocurrency innovation, central banks took note that transactions are becoming more digital and people are transacting a lot online. The question is, as more transactions move online and people are using cash less, does it make sense for central banks to continue to offer a direct form of central bank liability to the public, in the form of digital cash? That’s the big underlying question. And then, what does that look like in the digital realm? One possible answer to that is central bank digital currency.
Cash is very private. If we want to make a transaction, we don’t have to talk to anybody else about that transaction, and we don’t have to get permission for that transaction…. You can just pay me in cash. In fact, I don’t even need to have identification for you to pay me in cash, I don’t have to have a mobile phone, we don’t have to be connected to the internet, we don’t even need electricity. Cash is very permissionless and very low friction, aside from the fact that you have to actually be in the same place at the same time. So cash has all these really amazing and important properties; it just doesn’t work digitally.
Angwin: Can you tell us what your ideal central bank digital currency looks like?
Narula: I think it needs to be really low friction. People should not have to sign a terms of service, or buy an expensive device, or sign up with a provider who has the opportunity to reject or restrict what kinds of transactions they can make. We need something really open, accessible, and inclusive. We have the opportunity to imagine something different. We can do more than just replicate the properties of physical cash digitally, which is already challenging enough, to be honest. It’s actually really hard to replicate the physical properties of cash digitally, especially the privacy properties, because you leave data trails all over the place. All the exciting innovation we’re seeing develop in the cryptocurrency world, those are all opportunities to think about how they could be applied to the public sector.
The analogy I like to use is the same one they use in the cryptocurrency world. It’s a little bit trite, but bear with me: It’s creating the internet of money. What does that mean? Before we had the web and even the internet as we know it today, banks and airlines and other institutions were connected. They could send messages computer to computer, but what we were missing was this ubiquitous, standardized layer for building websites, applications, and browsers. If we don’t innovate in public money, we’re not going to be able to fully achieve the dream of the internet of money, of seamless value moving around, where we have the ability to build applications with payments. Hopefully this type of innovation will allow us to reduce transaction fees and remove the need for intermediaries. We need a platform for innovation and money because even in the crypto world, we’re seeing that the parts that are really the hardest to deal with right now are where they interface with the public money world—with the fiat currency world.
One example is microtransactions, such as paying for news articles or watching a livestream. Our current payment rails, such as MasterCard and Visa, don’t allow that. That to me is the core of the problem: Our existing payment rails don’t even allow this type of experimentation. And payments are just the first layer of the beginning of building richer value-moving ecosystems on top.
Angwin: My current experience with something that feels like a digital payment is the interbank payment system Zelle. What does digital currency do differently?
Narula: The idea with a central bank digital currency is that it would be as if you paid that person with cash, meaning once it’s done, it’s done. Another big difference would be that instead of a liability on the intermediating institution, which is what you have with Zelle because you’re actually spending your deposits, it would be a liability on the central bank. Like cash, it wouldn’t matter if your bank went out of business or failed halfway through the transaction; you would get a higher level of certainty.
Angwin: One of the most compelling arguments against crypto that I’ve heard is that the irreversibility of these transactions is such an incentive for fraud. Do you agree that that’s a real risk with these types of systems? And secondly, is it worth it?
Narula: Where I disagree is where you address that problem in the technical stack. We’re very used to addressing that problem in the payment rails itself, which allows you to claw back a payment. But that has all sorts of hidden costs that we pay every day and that we don’t even see or know about.
We’ve gotten very used to our payment systems having a bunch of functionality embedded in the rails of the system. But that has caused things to be really inefficient, really expensive, and really hard to change. And so part of what I’m advocating for is moving from embedding too much functionality in the rails of the system, including clawbacks or transaction reversal, and moving them to the edges of the system or to higher layers.
Angwin: This feels a little bit to me like a solution in search of a problem. Maybe it’s because I’m very privileged in the banking system, but I just don’t feel like I’m paying too much to reduce the risk of fraud in the current payment systems.
Narula: Part of that might be because the costs are hidden from you. But I do think new technology paradigms are really hard to understand and measure and talk about and connect back to specific user problems, because we get so used to the costs and inefficiencies we have to deal with, we stop noticing them. We work around them. Personally, however, crypto is not changing my life in terms of the way I make payments today. It might in the future, but it’s also possible that it never will. Maybe instead we end up with a back-end change to financial infrastructure, and it’s not really visible to users, but maybe credit card interchange fees come down 50 percent and merchants only have to pay 1.5 percent instead of 3 percent in the United States.
Maybe that’s the way that all of this goes down—a back-end change that causes competition, where users don’t see very much except that prices are 1.5 percent lower across the board. But that’s still a big deal. That’s billions and billions of dollars.
As always, thanks for reading.
Best,
Julia Angwin
The Markup
(Additional Hello World research by Eve Zelickson.)