The future of money between sovereign digital currency (CBDC) and stablecoins. The Diem example

Introduction

Future money, that much is now certain, will no longer be solid cash nor conventional book money, but rather digital money, also called cryptocurrency. It is not held in a bank account, but in a digital wallet. Transactions are processed by a server network through a kind of multiple daybook (Distributed Ledger Technology (DLT)) and stored in a resulting blockchain. There are other possibilities without DLT and blockchain, for example eCash and GNU Taler software as smartphone apps using blinded signatures.[1] The state of the art is constantly evolving.

Independently, the currency units are informational tokens. They are transferred directly from payer to payee, from one digital wallet into the other, without indirect money transfer by banks and other payment services. In this regard, digital money is like cash, that is, a bearer instrument that is passed directly from hand to hand. Hence the terms 'digital cash' and 'coins'.

Less clear is from whom such digital money originates, who creates it or puts it into circulation, in which way and in what currency unit. On this question, we are at a historical crossroads today. In one direction, there is the perspective of sovereign money, currently conceived of as central bank digital currency (CBDC), such as a digital dollar, yuan, euro, yen, pound etc. In the other direction, we are moving towards private digital currencies.

The best prospects among the latter to find general use as money are asset-backed stablecoins, as opposed to cryptocurrencies such as Bitcoin that are neither backed by assets nor by the power of a national government or large technology and financial companies. Stablecoins derive their name from being pegged in a fixed ratio to a national currency unit, usually 1:1 to the US dollar. However, they only have stable exchange value or stable purchasing power in the measure of the national currency in question.

An example of a stablecoin to be issued by a currency syndicate is the Libra, which was initiated by Facebook and has now been rebranded as Diem. The Diem stablecoin is seen here as prototypical. Even if the Diem were not to succeed, or the authorities do not immediately grant it a licence in all countries, existing stablecoins will expand and there will be further projects and market entries comparable to the Diem.

Between central bank digital currency and private digital currencies, there is unlikely to be much room for other means of payment in the longer term, especially as far as solid cash and conventional bankmoney are concerned. Bankmoney may still continue to exist for a longer period of time, and there may still be a certain cash reserve as an 'analogue' backstop against digital system failure. Over time, however, they are unlikely to persist. The same applies to new surrogates such as money market fund shares (MMFs), e-money, and over eight thousand private cryptocurrencies that are trying to gain a foothold in time despite their mostly low chances to succeed.

The Diem Stablecoin

It was to be expected that Facebook would not let up in its desire to establish a private megacurrency. In summer 2019, it was to be Libra, a stablecoin based on a basket of international reserve currencies. This met with strong resistance. The governments and central banks of the currencies concerned feared for their monetary sovereignty, and especially the US authorities - Treasury and Federal Reserve - for the hegemony of the US dollar.

Organisation and technology
In the meantime, the plan has been readapted. Libra is now called Diem. The Libra association became the Diem association, a currency syndicate consisting of 27 mainly American web, IT and financial companies. The organisation's headquarters were moved to Washington D.C. in May 2021, after the Diem Syndicate had previously applied without result to the Swiss authorities in Geneva for a licence. Not least, Calibra became Novi, a Facebook subsidiary that provides the digital wallets for the general use of Diem stablecoins. The firms Fireblocks and First Digital Assets provide wallets and platform infrastructure especially for financial institutions to connect to the Diem network.[1b] Operations are to begin as soon as the Swiss Financial Market Supervisory Authority grants the licence.

The main difference to Libra is that Diem is no longer a supranational basket currency, but a stablecoin based on a single national currency at a time – initially as a dollar Diem, later also as a Diem in other national currencies.

Technically, Diem is a cryptocurrency, managed as a blockchain by means of distributed ledgers. These form a kind of continuous journal, a register of transactions. It is maintained identically in form and content at several validator nodes that constitute the Diem network. The nodes are servers operated by member companies of the Diem syndicate. The main task of the nodes is to confirm the execution of payments and add them to the blockchain. Unlike 'open' or 'decentralised' blockchains, the nodes in the Diem network and the Diem users must be authorised (permissioned). Nodes and Diems are scalable, that is, they can be expanded or reduced in size.

When combined with smart contracts (shared computer protocols), the Diem becomes a programmable means of payment. This means, for example, that payments can be made automatically according to the terms of a contract or liability, even in ongoing supply chains or transactions in the internet of things directly from and to products, machines, plants. Conventional transfers of account balances cannot do this in the same way, nor can cash. Smart contracts can to some extent replace expensive notarial documentation and conventional ways of managing property and use rights.[2]

Prospects for acceptance and dissemination
Besides being programmable, Diem promises easier and faster transfers than the competition, also worldwide, and above all 'low-cost payment'.[3]/[4] A system with user authorisation and a reasonably limited number of nodes can probably do this. This means a certain rapprochement to conventional and liable trusteeship. As far as all this will actually be the case, the Diem can expect acceptance and growing market penetration among a wide range of user groups.

Success of the Diem then depends on a user network of critical size with payments in critical volumes. Only if many firms – probably first in commerce and services, then beyond – accept payment in Diems and also use them themselves, will a sustainable and self-reinforcing transaction network emerge. This is helped by the fact that most members of the Diem syndicate are companies with large international network potential. Facebook alone has 2.7 billion users. If only a few percent of them use a few hundred dollars or euros in Diems, this can already generate a payment volume in the double-digit billions.[5]

Things certainly don’t develop overnight. But over time. As the development of web-based business sectors so far has shown, they can go from inconspicuous beginnings to new large business sectors and market-dominating corporations within 5–10–20 years. Striking examples are the American platform corporations Apple, Microsoft, Amazon, Alphabet (Google) and Facebook, as well as the comparably large Chinese web platforms of Tencent and Ant Group (Alibaba). Their digital payment systems, including wallets called WeChat and Alipay, have become so widespread in China and increasingly other Asian countries in just a few years that many businesses now have to use them to stay in business.

Similar e-money systems also exist as M-Pesa in several African countries or as dinero electrónico in Latin America. In the Bahamas, a mobile phone e-wallet for the digital Sand Dollar is available for everyone since October 2020. Cambodia is about to launch its digital Bakong. Similar projects are underway in Ukraine and Lithuania. This is on a smaller scale than in China. Nevertheless, these developments are domestically significant, even systemically relevant, particularly in countries where only a few people have a bank account, but many people have a mobile phone. This is what the Diem makers have in mind when they talk about contributing to the 'social inclusion' of the unbanked of this world. The more explicit meaning of this rhetoric is likely to read that the prospective clientele in their billions might turn out to become a multi-billion big business.

Alipay and WeChat are still payment services, as are M-Pesa and other providers. Using their intermediary e-money, they transfer bankmoney or deposited cash as a trusted third party. According to plans of the Chinese central bank, however, Alipay and WeChat soon ought to use e-yuans (DCEP = Digital Currency Electronic Payment of the People's Bank of China). Alternatively, they might issue stablecoins backed 1:1 by central bank reserves or e-yuans.

However, Tencent is also the company that exemplifies the Big Brother dangers of digital payment. It is true that the problem of data protection and informational privacy has long existed in cashless payment transactions. But the digitisation of all areas of life further intensifies the problem, also as a problem of cyber attacks and cyber crime.

Digital currency in itself is largely safe and secure, at least more so than conventional account-management and payment systems. But every system always remains 'imperfect' to some extent, 'open' to error or failure, even if with low probability. For example, anyone who would control 51% of the computing power for a blockchain could, in principle, manipulate it. So far, however, a weak point has been the trading platforms that exchange digital currency in and out. The digital user identity and the wallet code can also be points of attack. ECash software and GNU Taler software using blinded signatures, however, seem to be particularly safe.

Backing and profit generation
Diems are issued by Facebook's subsidiary Novi and can be bought on digital currency trading platforms, 1 Diem for 1 US dollar in bankmoney, or perhaps other cryptocurrency, or MMFs. One of the most popular trading platforms, Coinbase, as well as the platform Xapo, are members of the Diem syndicate. The Novi app required to use Diems can be run independently of using Facebook or Whatsapp.

By its 1:1 issuance, Diem would be 100% backed by bankmoney or 'cash-equivalents', that is, easily liquidable securities such as government bills, short-time bank deposits, bankers' acceptances and commercial paper. Such asset-coverage is the main reason why stablecoins have a much higher chance of being adopted as money than unbacked cryptocurrencies like Bitcoin. The computerised 'mining' of Bitcoins follows, admittedly, a fixed algorithm which does not allow for a 'scalable' Bitcoin quantity. That's why Bitcoins are also referred to as ‘digital gold’. Wrongly so. There is nothing and nobody behind Bitcoins and similar cryptocurrencies. Therefore, while they may be suitable as tokens in the global casino or for money laundering, they have no chance of gaining general acceptance as a regular and commercially clean means of payment. They may serve as a transitory payment vehicle, but as a regular means of payment in continuous use and large quantities they will only be held for speculative intent.

The Diem syndicate promises to keep fees for using the Diem infrastructure very low. But if hardly any fees are taken, the syndicate's earnings must come from other sources. One of these might be the marketing of user data or advertising space. Primarily, however, earnings are supposed to come from investing part of the 1:1 coverage in those 'cash-equivalents and very short-term government securities'.[6] In this respect, Diem would work like an MMF. It remains unclear, however, what the percentage of government securities and 'cash-equivalents' in the 100% asset backing of the Diem should be.

In the long run, the syndicate might also ask itself whether it necessarily has to be short-term and triple-A-rated government bonds or whether other types of investment with higher profit opportunities could be used. Equally, it remains unclear whether a purely passive issuance policy is being pursued (Diem against bankmoney according to customer demand), or whether an active issuance policy is not also being pursued, for example by Novi directly buying securities on the open market with new Diems. In each of these respects, there is potential for the development of fractional reserve banking in a new context. The issue has already become topical with Tether, the most widespread stablecoin to date.

Interoperability, convertibility
As announced now, Diem is not inter-operable for the time being, or only to a limited extent. This means that Diem cannot be easily connected to other types of money and payment systems, for example to transfer amounts in Diem to a bank account, or vice versa. As long as Diem is only available as a US dollar Diem, no direct currency exchange is possible. However, Diem can be redeemed for bankmoney or cash on pertinent trading platforms.

In the longer run, such obstacles would be removed. Should Diem become widespread, it is to be expected that interfaces to other types of money, currencies and payment systems will be increasingly established. This would be all the more true if major banks were to start issuing stablecoins of their own.

Long-term impact assessment

Strengthening of US dollar hegemony
Central banks and ministries of finance are currently working on regulation of cryptocurrencies. The US Treasury and the Federal Reserve are certainly among the regulators and policymakers with whom representatives of Libra and Diem have met in the last two years. Both authorities took a negative stance against Libra in summer 2019, while they apparently have no objections to Diem. What makes the difference here is the change from a supranational multi-currency stablecoin to a single-currency stablecoin initially and exclusively denominated in US dollars. This takes into account the interests of these authorities. A stablecoin denominated in US dollars and in widespread use is suitable to strengthen the global dollar hegemony, in developing countries and emerging economies as well as in old and newly industrialised countries.

Whether dollar-denominated means of payment have the form of dollar notes or bankmoney or MMFs or stablecoins is not unimportant for the US Treasury and the Federal Reserve, but of utmost importance it isn't either. A Diem stablecoin expanding successfully and also internationally will undoubtedly be an additional element in the dollarisation of world finance and global trade, strengthening the international influence and sanctioning clout of the USA, in addition to using the infrastructures of central banks and bankmoney to that end.

Private cryptocurrencies, if not properly regulated, are bound to create the same functional problems and crises as bankmoney
Coverage of money by other types of money and assets never provides complete security. Second- and third-tier money, as well as a national currency together with central-bank money, can be pressured and subject to a run. This is all the more true for backing by securities. The value of such financial assets fluctuates incessantly according to market conditions, so that the relevant reserve positions of a stablecoin gain or lose value. This would be exacerbated if, over time, stablecoins were subject not only to a passive issuance policy, but possibly also to an active one, for example by Novi directly buying securities on the open market with newly created diems.

There is thus a certain potential that stablecoins do not fulfil 100% coverage in bankmoney and various types of securities. This means that fractional reserve banking can arise with stablecoins as much as with bankmoney, and a run on digital cryptocurrency can occur analogous to a run on bankmoney. And the more Diem or any other such stablecoin spreads and becomes systemically relevant, the more the problem of 'too big to fail' is reproduced. If stablecoins of weight enter a crisis, for whatever reason, central banks and governments will have to warrant the existence of systemically relevant private money surrogates and, if necessary, support and stand bail for them in order to prevent worse.

Today's monetary system has already changed from a two-tier system to a three-tier system. At the base level, there are the reserves and cash of the central banks as legal tender. The second tier is bankmoney on a small base of central-bank money. Bankmoney is private money that has acquired a para-state status in the course of the 20th century through its being warranted by central banks and governments. New types of third-tier private money include MMFs, e-monies and private cryptocurrencies, predominantly on the basis of bankmoney.[7]

Among the new types of money, only MMF shares have been of significance so far, amounting to half to twice the bankmoney, depending on the currency area. Despite their 1:1 coverage in financial assets, indeed precisely because of this, a number of them got into difficulties in the 2007/08 crisis. Insofar as Diem materialises, one has to reckon on the one hand with already existing stablecoins such as Tether, USD Coin oder Binance USD taking a further upswing, and on the other hand new currency syndicates coming up. Should this actually happen, the most important of these stablecoins would soon be systemically relevant.

The new types of money increase complexity of the monetary system. If now, in addition to hitherto firmly established bankmoney, new third-tier money surrogates are tolerated or even promoted in growing numbers and quantities, the complexity of the unfolding three-tier money system will definitely become unmanageable. Already the bankmoney regime is largely out of control. What then is the situation going to look like in a three-tier system with a larger number of new private means of payment, large payment volumes, and a large new sector of shadow banks.

Unlike MMFs and e-money, the new stablecoin sector is still largely unregulated – although this means less than one might think, because as previous regulations show, all sorts of things are regulated, for example liquidity and equity requirements under conditions of fractional reserves, but not what matters most: the control of money creation. Public blockchains – that is, open or freely accessible ones – are beyond control anyway, both nationally and across borders. That is why China has increasingly restricted the mining and trade of Bitcoins. India is planning an outright ban. This would create a criminal offence that can be prosecuted de jure, but hardly de facto.

Those who in the tradition of free banking doctrines believe that the notoriously overshooting, sometimes also stubbornly faltering, money and financial markets will sort things out on their own are repeatedly proven wrong. In actual fact, the instability already inherent in the current monetary and financial system will increase with the spread of private digital currencies.

Stablecoins compete with bankmoney, new financial institutions with traditional banks
The spread of stablecoins will reinforce the general trend of shifting financial transactions from banks to shadow banks (from monetary to non-monetary financial institutions), to the detriment of traditional banks and the use of bankmoney. The banks themselves have much helped create and finance that development, be it through subsidiaries under the umbrella of their own banking group, or through funding external financial institutions. Conventional banking corporations have become more and more active in areas such as investment, asset management and brokerage, while other financial institutions are active not only in money exchange and payment services, but also in various branches of the lending and investment business. Such overlaps continue to increase. In view of the new types of third-tier money now, the traditional distinction between monetary and non-monetary financial institutions, banks and shadow banks, soon no longer makes sense, at least not the same sense as previously.

The fact that stablecoins are initially based largely on a base of bankmoney does not protect the banks in the long run. After all, it has not protected cash and the operationally necessary base of excess reserves from dwindling that they are the fractional base for bankmoney. A growing share of securities or even new money surrogates in the asset backing of stablecoins, together with growing large payment volumes in stablecoins, reduces the need for bankmoney and the demand for it, both in the general use of bankmoney and as a base for new third-tier money. This would be reinforced if the Diem syndicate and other such providers do not limit themselves to payments, but also offer other typical banking services such as granting loans, financing companies and making investments. With Alipay, for example, this is already the case on a large scale.

Bill Gates summed up these perspectives in a bon mot: 'Banking is necessary, banks are not'. Initially, the Libra project also included large credit card companies that are banks themselves and cooperate closely with banks. At a certain point they apparently realised that Libra and Diem would compete with the conventional banking sector. They would literally have nourished a viper at their bosom that will bite them, threatening traditional banks and bankmoney the bigger and more systemically relevant the new private currencies and related new financial institutions grow - growing into banks in all but name and the para-sovereign bankmoney privilege that goes with it.

The traditional banks are certainly not surrendering to their fate without resistance. They, too, are restructuring and retooling. Domestic near-realtime transfers of bankmoney are already possible. Nevertheless, bankmoney is still traditional book money, not digital tokens which can be transferred directly without any intermediate step and are also programmable. This has been evident for years especially with international payments. As a bank transfer, these are still expensive and can take several days. With digital money, both domestic and cross-border payments are instant and cheap. Even many banks use cryptocurrencies as a vehicle for international payments, for example the digital payment system of the cryptocoin Ripple.

What seems to be more obvious for the banks in this situation than to create their own digital tokens. Large banks associated in a syndicate could, if tolerated by the central bank, issue a stablecoin denominated in a currency of their own, scalable and programmable like other digital money. Of course, these would then be stablecoins like those of other new currency syndicates, without refinancing privileges and without support from central bank and government. This would then also include a correspondingly high level of reserves. Seen like this, it would be easier, more efficient and therefore cheaper for the banks to use central bank digital currency (CBDC) straight away.

Alternatively, banks could consider converting current account balances into digital tokens. This would then be 'digital bank cash', quasi analogous to erstwhile private banknotes before these were replaced in the 19th century by the central-bank note monopoly. Current accounts would remain possible for the time being. The conversion and thus de-activation of bankmoney in conventional savings and time deposits would also continue to be possible.

Tokenising bankmoney, however, presupposes central bank and government to tolerate this as well as the banks to accept each other's bank tokens. Tokenising bankmoney would even be promoted by the state if central bank and government would warrant the existence of bank tokens as they warrant the existence of bankmoney up to now. In doing so, however, they would expand fractional reserve banking and counteract increased effectiveness of monetary policy through CBDC.

Moreover, things would in actual fact only work when CBDC is available for the possible encashment of bank tokens, because converting the 'digital bank cash' into solid cash (de facto smaller money) is largely out of time already today, and central-bank reserves are not accessible to the public. As soon as CBDC becomes widely available, however, the central bank would have to push for a 1:1 backing of digital bank tokens by central-bank money and easy to liquidate assets, similar to MMFs and e-money, in order not to gamble away effectiveness of monetary policy again which is basically increased by introducing CBDC. Such 1:1 backing would in turn be comparatively expensive for the banks, so that here, too, in addition to sticking to conventional bankmoney, the use of CBDC straight away is likely to be closer for the banks than putting their own digital bank tokens into circulation.

Stablecoins, backed by financially strong corporations, do have a chance of success. Once they are allowed to enter the domain of cryptocurrencies they will not only affect the existing second-tier bankmoney, but also the other third-tier money surrogates. For example, the question is whether stablecoins will displace MMF shares in the payment function, or whether both will coexist in the long run as new means of payment. MMFs have the advantage that the shares earn interest, albeit only a small amount for the foreseeable future. However, they have the disadvantage, which bank deposit money also has, that they are not programmable. But why not tokenise MMF shares? MMFs would then be a variety of stablecoins. Basically this also applies to all kinds of e-money that would be tokenised.

Stablecoins in competition with central bank digital currency (CBDC)
The competition between para-sovereign bankmoney and private cryptocurrencies is highly relevant. Of truly fundamental importance, however, is the question of whether CBDC will gain the upper hand and thus become the dominant and system-determining money of the future, or whether it will continue to be bankmoney (presumably of decreasing importance) or private stablecoins (of presumably increasing importance). This would be a world in which central banks might still exist, but in limited function, partly as bank supervisors with a broader meaning of the term 'bank' and in cooperation with financial market supervisors, partly as crisis managers, partly as bank liquiddators or bank restructurers in continuation of the function of a bailout financer of last resort.

The alternative to this - as is inherent in the constitutional law or state law of many countries - is to use the digitisation of money to preserve the states' monetary sovereignty, to endow it again with monetary substance in the form of central bank digital currency, and thus to effectively contain the de facto ungovernable complexity of a system with second- and third-tier types of private money, or to overcome these altogether.

If this does not succeed, monetary policy in the current sense will no longer exist. Already in today's bankmoney regime, monetary sovereignty has been reduced to warranting the national currency unit, whereas there is no longer any question of the sovereignty of money creation and seigniorage. It is certainly gratifying that the advent of digital money has created a new awareness among central bankers, politicians and the public of the importance of a state's monetary sovereignty. However, the fact that monetary sovereignty must also include the sovereignty of money creation and seigniorage does not yet seem to have fully filtered through. It is not a balanced view of things to portray stablecoins like Diem as a 'wolf in sheep's clothing', while ignoring the realities of conventional bankmoney.[8]

Stablecoins compete with central-bank money in the same sense as bankmoney did before: Bankmoney has displaced central-bank money in public circulation (cash) or pushed it back operationally in interbank circulation (necessitated reserves). So in the course of time bankmoney has first become system-relevant and finally completely system-defining. The central banks became subordinate and reactive refinancers of bankmoney, even more so in times of crisis than under conditions of business as usual.

The bottom line is that CBDC as well as private stablecoins are likely to compete strongly with all other types of money and marginalise or even displace them over time. This concerns second-tier bankmoney as well as new third-tier means of payment such as MMF shares, e-money and uncovered cryptocurrencies. At the same time, CBDC and private stablecoins of financially strong currency syndicates are competing against each other for system dominance.

Central bank digital currency (CBDC)

Rethinking. From being 'bank of banks' to being monetary state authority acting in the general interest
Since around 2016 a few central banks started to address the possibilities of CBDC and to develop concepts, mostly under the name CBDC. The terms CBDC and digital dollar, digital euro, digital yuan etc. are synonymous with regard to the type of money, even though there are partly different or undecided conceptual details. For example, the ECB is still undecided as to whether the digital euro should be conventional money-on-account or a digital token, a bearer instrument like cash.[8b] But there is now agreement among all important central banks that CBDC should be introduced.[9] The roll-out is mostly envisaged for around 2025, except in China, where it is announced for the Winter Olympics in February 2022. However, the e-yuan is not a digital token, rather a variety of 100% banking, i.e. a bank account accessible via an app, the balances of which must be backed 1:1 by reserves.[9b] How this is guaranteed in current payment transactions is not clear from the accessible sources.

Is CBDC sovereign money? Central bankers officially do not want sovereign money. More precisely, they do not want a full sovereign money system, in which there should be no more bankmoney and no other types of private money. Nevertheless, central-bank money largely corresponds to the definition of what sovereign money is: unrestricted legal tender. Treasury coins (as well as U.S. Treasury notes) and the notes and reserves of central banks are the only legal tender that exists. In this respect, they are sovereign money. Unrestricted, however, they are not. Cash is only practicable in small denominations and its use has also been restricted for regulatory reasons. At the same time, in the course of the 20th century, cash became a means of payment that is exchanged out of and back into precedingly created bankmoney, in this sense a subset of bankmoney. Systemically, cash has thus become largely irrelevant.

The reserves, on their part, are reserved for the banks and government transaction accounts at the central bank, thus withheld from the general public. The reserves are not irrelevant, the banks still need them. But in terms of their operational necessity and quantity, the reserves, too, amount to only a fraction of the bankmoney. CBDC in general use can and should change that ...

.. but the central banks are acting peculiarly defensive. For example, CBDC is said to complement cash and be a replacement for it should it be on the wane further on. At the same time, central banks intend to restrict access to CBDC regarding quantity and/or actor group. The declared intention is not to hurt the banks.[9b]

But why should CBDC be introduced at all if it is not supposed to spread and neither take market share from bankmoney nor deprive stablecoins of potential market share? This twofold competitive relationship is at best indirectly alluded to. The quasi-sole rule of bankmoney in the public money circuit, which would finally arise without cash, is not discussed. At most, one expects CBDC to increase the effectiveness of monetary policy - which, of course, an indirect understanding of conventional monetary policy not functioning anymore in the bankmoney regime.

Similarly, two issues seem to be of particular concern to central banks, concerning the interests of banks rather than the general public: Bank run and disintermediation. On the subject of bank run it is suggested that there could be a landslide from bankmoney into CBDC. Why? Under normal conditions there is no reason for this, and certainly not as long as the central bank and the government continue to largely guarantee existing amounts of bankmoney.

Apart from this, the concern is once again an implicit admission of the instability that is inevitably inherent in bankmoney on a fractional reserve base. There should be no ambiguity: Bank runs are the problem of bankmoney since it exists, it's not a problem of central-bank money, which is sovereign base money, no second-tier or third-tier promise of such.

Why not argue: the more CBDC there is, the less danger there is of bank runs due to liquidity and solvency crises of the banks. In monetary terms, the answer to the bank run issue is anyway for the central bank to issue a conversion guarantee to enable the exchange of bankmoney into CBDC at any time by providing the corresponding funds. The banks can work with CBDC just as well as they formerly used to with cash, and cheaper to handle.

While the bank run issue is real, although less problematic than assumed, the disintermediation issue is fictitious. It reads that if the public exchanges bankmoney for central-bank money, the banks would lose customer deposits and thus a means of financing banking activities. This could lead to a shortage of money and a credit crunch. This does not apply. The funds the banks need for doing banking business is central-bank money in the form of reserves and cash. With regard to their proprietary business, banks cannot do anything with their customers' account balances. Banks are not financial intermediaries that would take their customers' money upstream in order to lend or invest it downstream. Instead, banks are the creators of the bankmoney for non-bank customers. Only these can lend or invest already existing bankmoney in transactions with other non-banks. The actual financial intermediation takes place in the realm of non-banks, particularly shadow banks (non-monetary financial institutions).

If the public increasingly uses CBDC, then this will also flow to the banks to a greater extent - through the banks' current inflow, or backflow, respectively (repayments, interest, trading proceeds), which would already cover most of what banks needs, then through borrowing CBDC from other financial institutions and from customers, as well as through issuing bonds or similar debentures. Raising CBDC from banks and non-banks is in fact a way of financing for the banks, unlike the largely 'empty' pledge of bankmoney that is issued by the banks, but cannot be used by the banks once in circulation thereafter. As far as shadow banks are concerned, they too work just as well and cost-efficient with CBDC as they do with bankmoney. If the central banks ensure that there is enough money – which they can do at any time if they want – then there can be neither a shortage of money nor a credit crunch for monetary reasons.

Central bank purchases of sovereign debt as a regular means of CBDC issuance
Most of the unfounded worries about bank financing would be rendered irrelevant if the trillions that flow to the banks in the form of excess reserves as a result of Quantitative Easing were made usable for the banks as CBDC and thus also accessible to the public. This would take the wind out of the sails of the bank run worries and the fictitious disintermediation issue.

The policy of Quantitative Easing has been in place since 2008 and has become by now a habitually used toolset. This is a good thing, and it should be maintained as a mechanism in moderate application in the future, especially under the aspect of the introduction of CBDC. For central banks to buy government bonds on the open market and pay for them with CBDC is an appropriate and effective way of bringing CBDC into circulation.

It has remained disputed in court whether the monetary policy of QE in the euro area violates Art. 123 TFEU (Lisbon Treaty). In fact, such QE is indirect monetary financing of government spending through massive open market purchases of government bonds by the European Central Bank. Instead of flooding the banks with an excess of not operationally necessitated reserves, the government bonds can just as well be paid for with CBDC, which thereby becomes available for general circulation.

As far as the legal side is concerned: Laws that do not stand the test of realities and prohibit what is functionally useful, or even necessary for practical reasons, ought to be amended accordingly. The prohibition of the central bank to directly contribute to government financing is first and foremost in the interest of primary-dealer banks, pension funds and the like. The prohibition does not exist everywhere. The Bank of Canada directly absorbs one fifth of the Canadian government's bond issue, thus bypassing banks and institutional investors.[11] This works smoothly and no one finds it particularly remarkable.

Design principles for stablecoins and other types of third-tier money
To maintain or regain monetary sovereignty, the way must be paved for CBDC, while the spread of new third-level money surrogates must be contained and kept under control. In this respect, the regulation of MMFs and e-money has already been a step in the right direction. This needs to be further developed and applied to stablecoins. From the perspective of monetary sovereignty the most important principles of such regulation are the following:

· Stablecoins such as the Diem, MMFs and e-money must be issued 1:1 against bankmoney or central-bank money. All other means of payment are excluded from buying and backing third-tier money.
As as CBDC becomes generally available, only central-bank money shall be allowed to cover third-tier currencies.

· The money paid in must be held in full or at least at a very high percentage. A small proportion can be invested in government bonds at a yield. The percentage of obligatory money coverage is set by the central bank on a statutory basis. (It follows that the use of third-tier money costs the users something, similar to the way the use of other money entails costs, e.g. in the form of bank account fees).

· The money paid in to back stablecoins and other third-tier money must be denominated in domestic currency. Similarly, the government bonds which serve as a cover reserve must have been issued by government agencies or other public-law institutions of the respective currency area.

· Third-tier currencies must be denominated in their own name. They must not be denominated in a government or supranational currency, even if they tie their exchange rate to one.

· The issuers must operate a passive currency regime; an active regime is not permitted (e.g. purchase of securities with the private issuer’s own currency, or deliberate deficient coverage of the issued means of payment).

· A guarantee of the stock of third-tier means of payment, or support or rescue of the respective sponsoring companies, by the central bank or government is excluded.

Design principles for CBDC
Design principles from the perspective of monetary sovereignty can also be formulated for the introduction of CBDC and its relationship to bankmoney and stablecoins. These principles will determine the extent to which CBDC can become the dominant system-determining money, or whether the current extensive marginalisation of central-bank money will continue. Such design principles are currently being discussed in detail.[10] This will not be repeated here, but at least the most important of these principles will be listed:

· There is no restriction on access to CBDC. CBDC is a universal means of payment for all types of liabilities and all actor groups, for non-banks as well as banks, for big money and small change.

· As long as bankmoney exists, CBDC and reserves held by banks in a central-bank account should be interchangeable at the central bank. Monetarily, they belong to the same monetary aggregate (today M0).

· For the public, bankmoney and CBDC should be convertible in both directions without restrictions ...

· ... including a conversion guarantee by the central bank, also to prevent a run on bankmoney. This implies that CBDC is not subject to any fixing of quotas.

· State warranties of bankmoney are gradually to be reduced and eventually removed.

· Public authorities and other institutions under public law are to gradually expand of the use of CBDC. The state can demand that taxes, fees, etc. are paid with legal tender. This requires CBDC to be available in sufficient quantity. At the same time, this would exclude new third-tier means of payment. Second-tier bankmoney would be affected if and to the extent that government bodies settle all transactions via central-bank accounts rather than much of it via bank accounts, as is the case today.

· CBDC is not supposed to be interest-bearing. Only credit bears interest, not the means of payment. However, as far as banks pay deposit interest on current account balances (= cash credit of the customers to their banks), the central bank might consider an equal interest rate on CBDC.

By the same token, negative interest rates on money holdings would have to be ruled out. In a well-managed monetary system, there is neither too little nor too much money supply, hence no tendency towards zero interest due to an oversupply of money in a function of debt capital.

· CBDC also ought to be issued by way of genuine seigniorage, not only through central-bank credit to banks. While indirect monetary financing of government expenditure through Quantitative Easing is still controversial, this does not apply to the transfer of central-bank profit to the public purse. Seigniorage, that is, revenue from money creation and in the form of sovereign money creation, is part of a central bank's profit.

* * *

Each step in the indicated direction promises somewhat less instability and crisis-proneness in the monetary and financial systems, in particular also fewer imbalances in the use of money between the real economy, GDP-contributing finance and non-GDP finance. Put positively, each step in the indicated direction brings a little more monetary and financial stability and a somewhat better balance in the use of money, income and wealth distribution.

References

Bank for International Settlements. 2020. Central bank digital currencies: foundational principles and core features, publ. by BIS and the central banks of Canada, EU, Japan, Sweden, Switzerland, England and USA, Basel 2020.

Bank of England. 2020. Central Bank Digital Currency. Opportunities, challenges and design, Discussion paper, March 2020.

Becklumb, Penny / Frigon, Mathieu. 2015. How the Bank of Canada Creates Money for the Federal Government. Ottawa: Library of Parliament, Publ.No. 2015-51-E, 10 Aug 2015.

Bjerg, Ole. 2017. Designing New Money – The Policy Trilemma of Central Bank Digital Currency, Copenhagen Business School Working Paper, June 2017.

Boar, Codruta / Holden, Henry / Wadsworth, Amber. 2020. Impending arrival – a sequel to the survey on central bank digital currency, BIS Papers No. 107, Basel: Bank for International Settlements, January 2020.

Chaum, David / Grothoff, Christian / Moser, Thomas. 2021. How to issue a central bank digital currency, SNB Working Papers 3/2021, Bern: Schweizerische Nationalbank.

Dalton, Mike. 2020. What Is Diem? Introduction to the Facebook-Backed Stablecoin, Crypto.com, Dec. 17, 2020.

De, Nikhilesh. 2020. Libra rebrands to 'Diem' in anticipation of 2021 launch, coindesk, Dec 1, 2020.

Deutsche Bank. 2020. The Future of Payments, Corporate Bank Research, January 2020,
Part I – Cash: the Dinosaur Will Survive … For Now.
Part II – Moving to Digital Wallets and the Extinction of Plastic Cards.
Part III – Digital Currencies: the Ultimate Hard Power Tool.

Deutsche Bundesbank. 2020. Money in programmable applications. Report of the working group on programmable money, Frankfurt 21 Dec 2020.

Diem Association. 2020. White Paper, Dec 2020, https://www.diem.com/en-us/white-paper/

Engelmann, Stefanie. 2020. Aus Libra wird Diem, biallo.de, 3 Dez 2020.

European Central Bank. 2020. Report on a digital euro, Frankfurt: ECB, Oct 2020.

Hess, Simon. 2019. 100% E-Money and its Implications for Central Bank Digital Currency, SSRN paper, June 26, 2019, http://dx.doi.org/10.2139/ssrn.3410242.

Huber, Joseph. 2019. Digital currency. Design principles to support a shift from bankmoney to central bank digital currency, real world economics review, issue no. 88, July 2019, 76–90.

Huber, Joseph. 2020. Theorie dominanten Geldes I. Taxonomie des Geldes und monetäre Tidenwechsel, https://vollgeld.page/dominantes-geld-i-taxonomie-und-monetaere-tidenwechsel. Engl. Dominant Money Theory, SSRN paper, Jan 2020, https://papers.ssrn. com/sol3/papers.cfm?abstract_id=3513411 or https://dx.doi.org/10.2139/ssrn.3513411

Kumhof, Michael / Noone, Clare. 2018. Central bank digital currencies – design principles and balance sheet implications, Staff Working Paper No. 725, May 2018, London: Bank of Endland.

Monetative. 2020. Digitales Zentralbankgeld aus Sicht der Zivilgesellschaft, Positionspapier verfasst von Simon Hess und Simon Sonnenberg, Berlin, Juni 2020.

OMFIF/IBM. 2019. Retail CBDCs, the next payments frontier, London: Official Monetary and Financial Institutions Forum / Costa Mesa, CA: IBM Blockchain Worldwire.

Positiva Pengar / Monetative. 2019. The Future of Money. CBDC and beyond, Proceedings of the conference held in Stockholm in June 2019: https://conference2019.positivapengar.se/ videos-resources.

Ruzicka, Angelique. 2020. Should you seize on Diem? Thisismoney.co.uk, 23 Dec 2020.

WEF. 2019. White Paper on Central Banks and Distributed Ledger Technology, Davos: World Economic Forum, March 2019.

Endnotes

[1] See Chaum/Grothoff/Moser 2021.

[1b] Ian Allison, Coindesk, Feb 16, 2021; /cryptocurrency, Jan 01, 2021.

[2] On programmable digital currency cf. Bundesbank 2020.

[3] Diem White Paper 2020, cover letter 02.

[4] "Diem’s testnet has been criticised for handling between 6 and 24 transactions per second, far less than non-blockchain payment networks like Visa and Mastercard. But in practice, Diem's may be faster, as it aims to support 1'000 transactions per second". Ruzicka 2020.

[5] "If just 5% of Facebook’s 2.7 billion users buy $50 worth of the coin, Diem’s market cap would be $6.7 billion—enough to put Diem among the top five cryptocurrencies as of December 2020." Dalton 2020.

[6] Diem White Book 2020, Economics and the Diem reserve 04.

[7] For a taxonomy of existing types of money, cf. Huber 2020, Hess 2019.

[8] The German Finance Minister Scholz recently stated in a written communication: "We have taken note that the Libra project now wants to start in a new guise - under the Diem brand ... But, a wolf in sheep's clothing remains a wolf ... Germany and Europe cannot and will not accept a market entry as long as the risks are not adequately addressed in regulatory terms ... We must do everything to ensure that the currency monopoly remains in the hands of the state". Source: Finanzen.net, 7 Dez 2020; Süddeutsche Zeitung, 7 Dezember 2020.

[8b] ECB 2020 25ff.

[9] Cf. Bank for International Settlements 2020, Bank of England 2020, Boar/Holden/Wadsworth 2020, Deutsche Bank 2020, European Central Bank 2020, OMFIF/IBM 2019, WEF 2019.

[9b] Zum Beispiel EZB 2020 28ff.

[10] Cf., for example, Kumhof/Noone 2018, Bjerg 2017, Huber 2019, BIS 2020, Positiva Pengar/Monetative 2019, Monetative 2020.

[11] Becklumb/Frigon 2015.

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