17 May 2024

SUERF's Goel: The search for tokenised money: how about reserve-backed tokens?

Exactly what form the money of the future will take remains an open question. CBDCs, tokenised deposits, and stablecoins are potential candidates. Tokens that are entirely and exclusively backed by central bank reserves – ie reserve-backed tokens (RBTs) – also offer a credible solution.

RBTs pose a unique combination of benefits. They are safer than, and can crowd out, the unstable breeds of stablecoins. They can adopt a more flexible design than retail CBDCs and thus foster greater competition and innovation. Compared to bank deposits, RBTs are immune to runs and are unencumbered by legacy features. Naturally, there are attendant risks and unknowns, but careful design and gradual rollout can help harness the benefits of an RBT while mitigating the risks.

Introduction

Technological advances such as distributed ledgers and tokenisation are forcing a fundamental rethink about money among policymakers and financial service providers. This shift also reflects users’ changing expectations. As such, the search for a money that is more suitable for increasingly digitalised economies is underway. While much of the money currently in use is already in digital form (eg bank deposits and e-money), recent focus is on tokenised money. Central banks are studying retail CBDCs, with some live rollouts already. Commercial banks are exploring tokenised deposits. And fintechs are issuing a wide variety of stablecoins. This brief examines a yet another form of tokenised money: tokens issued by regulated private entities that are solely and fully backed by central bank reserves, or reserve-backed tokens (RBTs).

RBTs are not an entirely new concept. Researchers have previously argued in favour of related arrangements.¹ The Bank of England’s preferred model for systemic stablecoins is to have them fully backed by central bank reserves.² In Hong Kong and the United Kingdom, select commercial banks are allowed to issue banknotes against a full backing of monetary authority securities or reserves. Going further back in time, RBTs find similarities with the narrow bank proposal in the Chicago Plan.

The goal of this brief is to present how an RBT could be designed to harness its potential as a tokenised money form, compare RBTs with alternatives such as retail CBDC, tokenised deposits, and stablecoins, and draw its implications for the financial system.

How to design an RBT

The overarching objective of an RBT is clear – to serve as a medium of exchange – but its optimal design is not. RBTs must add value relative to alternatives but not pose undue risks. This raises several design trade-offs.

A first issue is who should be given access to the central bank balance sheet and relatedly the license to issue RBTs. Banks may be a natural choice since they already have such access and are well regulated. However, not giving non-banks and fintechs access would raise fairness concerns. In the long term, therefore, a competitive licensing regime may be needed.

Second, the regulatory framework for RBTs could draw elements from the framework for banks but could be much simpler as banks are multipurpose entities that require more complex regulation. And while RBTs and stablecoins could share the same framework due to inherent similarities, oversight would have to be more stringent in the case of RBTs as they are ‘closer’ to the central bank.

Third, as a means of payment like cash, RBTs should not pay interest. Interest payments could jeopardize the very ethos of an RBT as then issuers would compete on interest rates and invest in riskier assets. A non-interest bearing RBT – combined with limits on wallet balances – would also help reduce the risk of disintermediating bank deposits and moderate the impact on the central bank balance sheet.

Fourth, to ensure that the RBT business model is a viable, interest on RBT reserves may be necessary. This would complement any transaction fee and auxiliary service fee charged by RBT issuers. And while paying interest on RBT reserves would entail a cost for the central bank, the RBT reserve rate could be distinct from the policy rate and instead be calibrated to match the profitability of peers in the payment business. Relatedly, keeping RBT reserves distinct from traditional ones would help limit an RBT’s monetary policy implications and also help from an accounting perspective. In terms of the operating model, a centralised ledger (like RTGS) may be used initially, while permissioned distributed ledger is likely to be more effective in the long term.

Finally, transfer models for RBTs – burn-issue (ie liabilities burnt and created during a transfer) versus bearer – entail trade-offs between singleness³ and functionality. Relatedly, interoperability with the crypto ecosystem would require balancing risk-management with wider appeal. As a result of these trade-offs, giving issuers some design flexibility – while ensuring a minimum degree of safety – could be the way forward. In the end, issuers may self-select into the type of RBT they would like to design depending on their target use case. This could support competition and innovation.

 

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