This is the second of two articles. You can find the first article here.
Major Central Banks across the world are in a tight race to deliver the first credible version of digital money. China is testing a digital renminbi version, whereby customers can transact payments over their mobile phones. Europe announced the launch of a digital Euro as part of the five-year plan. The Fed announced it would release a discussion paper this summer regarding digital payments, including respective appeals and threats of a central bank digital currency.
What follows are some considerations ahead of the Fed’s discussion paper.
Could such a CBDC initiative outshine the benefits of Bitcoin?
The main Bitcoin appeal is its trustless payment execution offering in a decentralized environment, fully supported by distributed ledger technology and ensuing peer-to-peer network, ringfenced by cryptographic code along with a limited supply of coins in circulation. Thus, the five key concepts representing a competitive advantage are (confidential) trustless payment execution, decentralized governance, distributed technology, cryptographic consensus protocol, and limited supply.
The four inherent weaknesses to Bitcoin are its execution speed, its use for ransomware and its inability to procure (even limited) leverage, away from derivatives structures, settled in fiat currency. But the most important drawback is its carbon footprint.
Bitcoin’s carbon footprint is an anathema in a world faced with a limited carbon reserve to maintain temperature increases beyond 1.5 degrees Centigrade. A recent study by Cambridge Center for Alternative Finance (CCAF) suggests that bitcoin mining consumes 110 terawatt-hours a year of electricity, about 0.55% of global electricity production, and as much as tiny countries like Sweden or Malaysia.
It triggers entirely misguided capital allocation in a corporate finance world still thoroughly blindsided by externalities.
Atlas Holdings invested in a dismantled Greenidge power plant in upstate New York in 2014 to convert and generate direct “beyond the meter” energy capacity to the benefit of Greenidge Generation Holdings, a Bitcoin mining operator. An example of vertical integration pursuit, which in the absence of pricing for externalities, entails immediate short term benefits for the Bitcoin miner to the detriment of longer term intergenerational commons and quality of life considerations.
Here lies the challenge to the Bitcoin disruptors. How and when could the Bitcoin consensus protocol be altered to minimize its carbon footprint without falling back on carbon offsets?
Could such Central Bank Digital Currency improve on Bitcoin’s heavy carbon footprint and lessen the tolls of the current six-headed crisis: health pandemic, social injustice, and inclusion, distrust in international trade and institutions, climate change, loss of biodiversity, and global monetary policy bereft of impactful policy tools?
CBDC should foremost identify multiple objective functions, but the principal constraint variable should be minimizing the carbon footprint. Yet this constraint hardly gets any mention in current CBDC research.
Several Central Banks’ remits are continuously expanded to integrate climate-related risks in their purview. Christine Lagarde. President of the European Central Bank, imparted earlier last month, “The ECB subscribes to the view that climate-related risks can be a source of financial risk and to that extent, it also falls within the mandates of central banks and supervisors to ensure the financial system is resilient to these risks.”
Referencing Minouche Shafik’s reflections in her recent book “What we owe each other” could opportunity and security be fundamentally reordered across society?
As such, could a currency be designed to erase things we want less of, like carbon and smoking, and incentivize stuff we want more of, like education, regeneration, and a greener economy?
Here lies the sweet spot of opportunity for CBDC as a complementary currency in the universe of cash, digital, and crypto currencies on offer.
Programmability, using smart contracts, is a potential and desirable feature of digital money. Smart contracts are computer code instructions that automatically execute all or parts of an agreement. These types of contracts, supported by Distributed Ledger Technology and tied to a particular taxonomy of green products and services, could allow an economic policy to be laser-guided to favor consumption of low carbon goods targeted to certain geographic areas with a sunset provision. Conditions precedent would allow for automatic execution and could have strong appeal in times of extended climate change duress in calamity-affected areas.
Furthermore, the sunset provision could be coupled to a CBDC value-erosion function over time if deflation concerns would have marred a specific region.
By extension, the CBDC utility could be governed by a value conversion matrix, linking the painkiller capacity of products and services on offer to the toll at hand. The discount in conversion rate would be more prominent for products and services availed by companies whose footprint contributes to climate change and biodiversity loss. The conversion rate would increase for companies that embed strong and sustained inclusion and diversity policies. Emerging disclosure requirements articulated by TCFD, CDP, and SEC amongst others, will provide transparent and accurate mapping of the companies’ respective footprints to assist in constructing such conversion matrices.
Monetary policy tools could be expanded by rolling out Targeted longer-term refinancing operations (TLTROs), first introduced by the ECB. This policy offers commercial banks long-term funding at attractive terms but on the condition to redeploy it to stimulate bank lending in the real economy. Green TLTRO could be provided to commercial banks with (green and traceable) CBDC on the quid pro quo to use it for bank lending to decarbonize the economy.
Similarly, green quantitative easing and bailout programs could be devised, injecting CBDC, against haircuts commensurate with the degree in ESG (Environmental, Social, Governance) feature intensity of the securities under consideration.
How could CBDC mitigate or even avoid an emerging systemic risk pattern?
Systemic risk could be thwarted by creating a new nature- or climate-centric anchor currency, which could autonomously re-allocate capital to where the most urgent societal challenges are.
A proposal has been articulated in a previous article to release IMF Climate coins, on the back of Special Drawing Rights (SDRs). Special Drawing Rights are international reserve assets created by the IMF in 1969 and whose value is based on a basket of five currencies—the U.S. dollar, the euro, the Chinese renminbi, the Japanese yen, and the British pound sterling.
SDRs, lying idle on the IMF balance sheet, could be bundled into an IMF Climate Coin in support of attaining the 2015 Paris Climate objectives. A signatory nation would receive an IMF Climate Coin against a permanent and third-party certified reduction of 1 ton of CO2.
This anchor currency, replicating store of value, could become the benchmark against which all other currencies, cash, CBDC, crypto currencies, or Stablecoins would be measured against.
Which function(s) would the CBDC eventually target: a medium of exchange, a unit of measurement, a store of value, or a relief and reward instrument?
The CBDC proposition offers a unique opportunity to introduce multiple functions at once and launch “an invisible hand” dynamic, re-allocating capital away from the extractive and degenerative economy towards a regenerative, redistributed, inclusive and fully decarbonized economy.
This is the end of second article. You can find the first article here.