Brazilian central banker describes how CBDC system can halt bank runs

In a paper recently published by the Bank for International Settlements (BIS), Fabio Araujo, an economist at the Central Bank of Brazil (CBB) who’s also responsible for the country’s central bank digital currency work, revealed that the monetary authority will have greater control over the population’s money once its CBDC is rolled out. Through the so-called Real Digital, the central bank will be able to halt bank runs and impose other restrictions on citizens’ access to money. 

Real Digital, the digital version of Brazil’s national currency, has been debated at the central bank since 2015 and will have its first tests in 2023 through nine solutions presented by private companies during the recent Lift Challenge event that was carried out by the CBB.

Cointelegraph reported that the value of the upcoming CBDC would be pegged against the national fiat payment system STR, also known as the Reserve Transfer System.

Brazil could soon be the next Latin American nation to regulate cryptocurrency. A bill has been in the works since 2019 and is now finally set to hit the Senate floor for a vote. https://t.co/ZYEfrsEwm8

— Cointelegraph (@Cointelegraph) February 23, 2022

Through Real Digital, the central bank says it wants to enable so-called smart payments within a regulated environment. Smart payments include smart contracts, transactions with Internet of Things devices and even Decentralized Finance (DeFi) applications.

In the BIS document, Araujo said the main objective of introducing a CBDC is to provide entrepreneurs with a safe and reliable environment to innovate through the use of programmability technologies that make smart payments a reality.

"Technologies available for smart payments, as seen in crypto assets, make room for new business models and are better suited to meet the population's demand," he said.

Related: Fed paper looks at the potential effects of CBDC on monetary policy

Central Bank may 'stop' withdrawals

In the paper, Araujo highlights that the central bank must maintain a partnership with the private sector in providing liquidity to the market. According to Araujo, the central bank envisions the coexistence between the Real Digital and private money issued by institutions regulated by the CBB in the intended smart payments.

Therefore, individuals could convert their deposits into tokens capable of accessing the services provided on this new platform, under a commitment that these tokens will be converted into Real Digital. In other words, banks will be able to issue their own tokens aimed at smart contract applications having their balance in Real Digital as guarantor of the operations.

"Commercial bank deposit tokens would inherit all the regulations and characteristics of their parent assets, such as fractional reserve requirements,” he said. “Likewise, [payment service provider] deposit tokens would inherit their characteristics, such as total reserve requirements.”

However, unlike the cryptocurrency ecosystem, in which users own their assets and no one can lock their operations, in Brazil's CBDC there will be a system to lock withdrawals.

Araujo points out that, at a given time and for various reasons, there may be a bank run where users wish to convert these tokens into the Real Digital that will be guaranteed by the central bank. To avoid such bank runs, the CBB already provides "backstops and restrictions on the conversion flow to and from CBDCs."

The central bank points out that the flow of exchange of these tokens to Real Digital would have a limit and would even need to be scheduled in advance. In other words, the central bank will have the power to control the flow of money within the system.

Related: Brazil Stock Exchange wants to provide oracles for Real Digital

The paper explains:

"One source of concerns, though, is the speed at which private tokens could be converted into CBDCs, which could restore coordination mechanisms. To avoid such undesirable flows, large conversions could only be available if scheduled in advance and constraints on daily conversions could be set. In addition to that, circuit breaker mechanisms could be automatically applicable when the continued draining of tokens from any specific institution would render it vulnerable.”

Araujo concludes the document by pointing out that Real Digital, by enabling smart contract and programmable money solutions in Brazil's financial environment, will allow the creation of customized financial services to meet the different demands of society.

The paper concludes that these resources, when combined with financial education, can provide efficiency gains and serve the entire population of the country, even those who are still on the margins of the financial system.