15. Central Banks & Commercial Banking, Part 1

What this lecture covers

This lecture opens a two-part module on central banking with guests Rob Ali (former Bank of England digital lead) and economist Simon Johnson. Gensler builds up from fiat currency basics to explain the three forms of money in a modern economy (physical cash, commercial bank deposits, and central bank reserves), how they connect through ledgers and real-time gross settlement systems, and why several central banks have run blockchain pilots for their payment infrastructure.

By the end, you should be able to distinguish cash, bank deposits, and reserves as forms of money, explain what a central bank's dual mandate covers, and describe the three phases central banks have gone through in testing blockchain technology for payment systems, using Singapore's Project Ubin as the running example.

Key ideas

• Three forms of money: physical cash (a token claim on the central bank), commercial bank deposits (the largest form of money, roughly $13 trillion in the US), and central bank reserves (the money commercial banks hold at the central bank).
• Fiat currency's network effect: fiat money is a social construct made durable by two features — governments require it to pay taxes, and it legally discharges "all debts, public and private."
• The dual mandate: US law directs the Federal Reserve toward maximum employment, stable prices, and moderate long-term interest rates; central banks manage money mainly through its supply (cash, reserve requirements, capital rules) and its price (interest rates).
• Cash trends diverge by country: cash as a share of GDP is falling sharply in Sweden (around 2%) while rising in the US (around 8%) and staying high in Japan and China (near 20%), and in the US most of that growth is in $100 bills, over half held outside the country.
• Real-time gross settlement (RTGS): the system, like Fedwire or CHIPS in the US, that moves money directly between banks and the central bank; this is the layer central banks have been testing blockchain against.
• Three waves of central bank blockchain experiments: Phase one (Canada's Project Jasper, Singapore's Project Ubin, and Brazil) tested permissionless Ethereum-style networks and found them unsuitable; phase two moved to permissioned platforms (Corda, Hyperledger Fabric, Quorum) in Japan, Europe and South Africa.
• Central bank digital currency (CBDC) does not require blockchain: it is inspired by the crypto movement but conceptually dates to economist James Tobin's 1980s proposal for direct public access to central bank money, independent of any specific ledger technology.

Walkthrough

Fiat currency and the three forms of money (6:04)

Gensler reviews why fiat currency works as money (its use for taxes and debts creates network effects) and diagrams how central bank reserves, commercial bank deposits, and physical cash relate, using a Starbucks purchase to show how paying by card moves a bank deposit rather than physical cash.

Cash trends and the store-of-value debate (14:10)

Using BIS data, the lecture compares cash-to-GDP trends across countries, noting Sweden's steep decline toward a cashless economy versus the rising share of $100 bills in the US, much of it held abroad or turned over slowly, which the class connects to the 2008 financial crisis eroding trust in commercial banks.

Central bank goals and the dual mandate (21:17)

Gensler covers the legal basis for central bank goals, the 1977 US "dual mandate" law, and a short history of central banking from the first Bank of the United States through the 1971 end of the gold standard, framing central banks as regulators, monetary managers, and lenders of last resort.

How central banks are approaching blockchain and crypto (44:53)

The lecture categorizes central bank responses into monitoring and studying (the dominant approach, including the US Fed), restricting use (China), payment system experimentation, and central bank digital currency initiatives. A show of hands reveals most students correctly understand that CBDC does not inherently require blockchain technology.

Payment system pain points and non-blockchain faster-payment efforts (47:59)

Recapping the previous lecture's payment pain points (cost, delayed settlement, chargebacks, fraud, privacy, financial inclusion), Gensler describes non-blockchain initiatives like Europe's TIPS, the US faster payments task force, India's IMPS, and the UK's open banking API mandate, which all aim to speed up payments without using a blockchain.

Singapore's Project Ubin and the three phases of central bank blockchain testing (49:05)

Gensler details Singapore's multi-phase Project Ubin, which tested Corda, Hyperledger Fabric and Quorum among 11 participating banks for real-time gross settlement, aiming eventually at cross-border delivery-versus-payment and payment-versus-payment systems. Rob Ali explains the rationale for keeping the central bank's role limited within such a system, to avoid recreating a single point of failure that undermines the benefits of decentralization.

Setting up central bank digital currency (1:01:52)

The lecture closes by framing CBDC as a strategic question — should the public have direct digital access to central bank reserves, rather than only intermediated access through commercial bank deposits — previewing design considerations (interest-bearing or not, token- versus account-based, retail versus wholesale access) that will be covered in Part 2.

Before you watch

• Watch the two Payments lectures earlier in this course, since this lecture builds directly on terms like clearing, settlement, and payment system pain points introduced there.
• A basic sense of how commercial banks and central banks relate (reserves, deposits, monetary policy) will help with the middle section on the dual mandate.

Check your understanding

1. What are the three forms of money in a modern economy, and how does a card purchase at Starbucks move between them?
2. Why does the US dual mandate direct the Federal Reserve toward both employment and price stability, and how do the two goals relate?
3. What did central banks learn in phase one of blockchain experimentation that led them to switch from permissionless to permissioned platforms in phase two?
4. Why does Rob Ali argue that a central bank should deliberately limit its own power within a distributed payment system like Project Ubin?
5. Does central bank digital currency require blockchain technology? Explain your answer using the lecture's argument.