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Digital technologies and expanding financial markets have generated during last couple of years viable discussions around the world about new types of digital currencies, DC. The debates encompass complex issues of new types of assets, new financial service providers and various forms of regulation. Several interconnected issues have appeared to affect the DC’s development and various payment solutions: stablecoins, new “DC-global central bank”, as well as the DC’ application on the national level, for citizens, businesses and retail.
Since the beginning of 2023, the majority of central banks around the world have actively begun exploring or developing “DC central banks” initiatives, the so-called CBDC initiatives, with notable progress in some large economies such as China, India and states in the European continent. However, initially several challenges appeared, i.e. ranging from technological and regulatory hurdles to meet economic considerations and public adoption, etc. which are all hindering the perspective and integrated DC’s development.
According to the Bank for International Settlements, BIS about 86 percent of central banks around the world are actively investigating DC’s potentials visualizing significant transformations in the near future. Some practical examples are already evident: e.g. China, with its digital Yuan “boasting” over 120 million wallets, and India, in the pilot phase since late 2022, to name a few; besides, the UK has been recently through a pilot phase alongside some smaller economies indicating a growing global trend toward DC implementation.
See, e.g. BIS report on crypto exchange in: https://www.bis.org/publ/work1201.htm
Whilst there is great interest and a move towards CBDCs in many countries, there are also a number of challenges with their implementation, requiring further local and international co-operation.
General source and reference: https://www.gft.com/uk/en/blog/central-bank-digital-currencies-cbdcs-a-global-perspective
Background
The advantages of crypto-currencies (and DC, in general) include cheaper and faster money transfers, as well as decentralized payment systems free from any critical economic calamities. However, there are some disadvantages too, including price volatility, high energy consumption for mining activities, as well as involvement of some criminal activities.
By a generally accepted definition, the digital money or digital currency, DC is any type of payment that exists purely in electronic form and is accounted for and transferred by digital means. At the same time, the “electronic money” or e-Money are used and exist in the banking computer systems and available for transactions through numerous electronic systems.
Some researchers have already tracked countries’ development and made some reflections on the global “central bank digital currencies, CBDCs; contrary to crypto-currencies like Bitcoin, a CBDC is backed by a central bank and is essentially a digital version of a country’s fiat currency. “Virtually all countries are exploring a central bank digital currency for potential use”, they noted adding that some states as different as e.g. China and the Bahamas, have already implemented them. This shift, the researchers believe, “could offer significant benefits over the current financial system by sidestepping the high fees and inefficient timelines associated with moving money, particularly across borders”.
Reference and citations from: https://www.gsb.stanford.edu/insights/cashless-digital-currency-future-finance
Price volatility and privacy
One of the negative DC’s aspects is price volatility, which could be quite high and hence unreliable. For example in the US, people for many years used bank accounts for retail and other things; now they are talking about a new central bank digital currency, often called “digital dollar”. It means that, first instead of paying money from a bank account one would be paying money out of an account with the Federal Reserve Bank as the US-wide central bank, which is, by the way, a lot safer for customers…
More on the US financial system in: https://www.integrin.dk/2024/08/12/financial-markets-in-europe-and-the-us-facing-digital-challenges/
Second, the digital dollar could be based on some blockchain structures, like Bitcoin, that would allow automatic and safe payment; e.g. buying euros with the digital dollars through blockchain means would guarantee getting needed euros; presently, the US banks are not providing a guaranty’s exchange transaction service due to price volatility.
Third, the issue of clients’ transactions, and “payments’ history”: presently, in the US (and in most other states) the authorities are not supposed to get access to personal transactions unless there is something suspicious: in that case the bank informs a customer and the government services. E.g. in 2023, there were 4 million of those suspicious activity reports or SARS sent to the government by banks. A small fraction of those payments appeared to be actually illegal; but the government could already acquire access to some potentially suspicious payments through “other means”.
Some suggested that if there were a digital dollar, the situation would be much worse because instead of asking banks to send that information, the government supposedly would have direct access to it. However, there are some misconceptions: it is not necessary that that digital technology provides “original information” to the government, and that the US Fed would almost certainly need to guarantee that it could not access personal payment information illegally.
Concerns about privacy could be a stumbling block in the DCs; it could be one of the reasons that DCs implementation by national central banks could be delayed until people are confident.
The issue of trust
The trust is also a focal feature in DC acceptance: i.e. based on a general trust in the key financial actors, such as banks, that handle registration of transactions and the value of the funds. This trust is specifically based on three factors: first, banks have assets, liquidity and capital to support and ensure the value of the funds.
Secondly, there is effective national legislation regulating these actors’ behavior, with capital requirement to ensure that they can withstand losses and caps on the risks that banks are allowed to undertake.
Finally, in some regions the deposit insurance scheme (e.g. the Guarantee Fund in Denmark) secures deposits of up to approximately 750,000 DKK in the event that a bank enters into liquidation.
These factors mean that both bank deposits and cash are still regarded as secure ways of storing value in the bank.
More in: https://www.nationalbanken.dk/media/z12aimyo/analysis-no-8-new-types-of-digital-money.pdf
Central bank digital currency
Commonly used abbreviation in the digital finance’s sphere is so-called CBDC, which stands for ‘central bank digital currency’ – a digital form of a world-wide and/or country’s national currency that is issued and regulated by the country’s central bank.
CBDCs are essentially a digital representation of a country’s physical currency (such as banknotes and coins) but in an electronic or digital form. However, unlike decentralized crypto currencies, such as Bitcoin, CBDCs are centralized and typically issued by the central monetary authority of a specific country. In the world-wide dimension, it could be the authority of the World Bank as a subsidiary of the “global government”, like that of the United Nations.
Among key DC’s features are the following:
= centralized issuance: CBDCs are issued and regulated by the central bank of an individual country, distinguishing them from decentralized crypto currencies that operate on distributed ledger technology but are only ‘governed’ by the market.
= legal tender: CBDCs are considered to be legal tender, just like physical currency; people and businesses can use them for various transactions, and they hold the same legal status as traditional forms of money.
= digital form: CBDCs exist in electronic or digital form, stored in digital wallets or other electronic devices; this allows for faster and more efficient transactions, especially in the digital economy.
– government’s backing: CBDCs derive their value and legitimacy from the backing of the government or a central bank. They are considered a liability of the central bank and are typically fully backed by the country’s reserves.
= controlled supply: each central bank has control over the issuance and supply of their CBDC. This enables the central bank to implement monetary policies effectively and respond to economic conditions.
Challenges: technological, economic and legal
Still, there are some administrative, technological and legal challenges that have to be dealt with in those complicated issue concerning the DCs introduction. Among some of them are:
– development of secure, efficient and scalable digital currency systems;
– management of cybersecurity, interoperability and handling of substantial transaction volumes;
– co-existence with traditional currencies, backward compatibility and technology choices;
– establishing a legal framework governing CBDC issuance and regulation;
– addressing privacy, data protection and compliance with international financial regulations; and
– providing clear legislation concerning “digital money’s programming”.
Despite the political challenges of transitioning away from traditional currencies, the US researchers believe that DC is having enormous potentials.
The main challenge, they say, is “striking the right regulatory balance between fostering innovation and mitigating risks”; for the US, for example, a digital dollar could be a solution.
Among economic considerations the following shall be mentioned:
= assessing potential economic impacts on monetary policy, financial stability and the banking sector;
= caps on wallet holdings, the non-interest-bearing nature, and implications for public acceptance; and
= in terms of monetary policy and governance, the decision not to implement CBDCs could be detrimental for central banks;
= finally, main DGs consideration and its “dark side” are about surveillance, loss of privacy, as well as the so-called iron grip on financial transactions.
As an alternative to government backed money, Bitcoin and other crypto-currencies are not a useful way to buy and sell goods and services, but the blockchain technology behind them has opened the door for a digital currency that is more versatile and more secure than traditional money.
China’s experience
The largest country that’s well along the way with a central bank digital currency is China. About four years ago, China began piloting project in the central bank digital currency; it was noted that only one percent (!) of the total amount of money issued by the central bank is covered by DC. However, people in China already has had access to a really whizz-bang electronic payment systems, EPS the two most popular of which are called Alipay and WeChat Pay, which are private sector payment systems put up by two of their largest tech companies.
The project would be similar in theory to Amazon, Google, Facebook or Microsoft, etc. to make available digital payment accounts to everyone and allow online customers to use their accounts for transactions, which could be, in fact, a powerful option for most of the states.
In China, mentioned two EPS payment systems account for almost all payments in urban areas.
Danish initiatives
Denmark has a safe and efficient infrastructure when it comes to payments and is a leader in the use of digital money. New types of digital money may potentially supplement the existing types, but they also involve new risks.
For the Danish National Bank, it is essential that the solutions are safe and efficient for citizens and society, regardless of provider and technology used. The three main objectives of Denmark’s National Bank are to help ensure stable prices, secure safe payments and a stable financial system.
More in: https://www.nationalbanken.dk/en/about-us/strategy
As to the EU-wide approaches to DC see our publications in: – https://www.integrin.dk/2024/07/22/anatomy-of-digital-finance-in-the-european-union/; – https://www.integrin.dk/2024/07/31/basel-iii-and-the-eu-banking-sector-strengthening-financial-stability-and-resilience/; – https://www.integrin.dk/2024/07/08/eu-financial-services-digital-perspectives/, etc.
Conclusion
The global trend towards digitalisation, the popularity of crypto-currencies, and the benefits which digital currencies can bring, all suggest that the CBDC solution is most optimal. The enhanced settlement efficiency, smart contract utilization, as well as improved financial inclusion are clear advantages of CBDCs.
Some challenges do exist, however; but increasing momentum towards digital currencies suggests that CBDCs are very likely to become a significant part of the global financial landscape in the medium to long term.
The global financial system is witnessing a substantial shift towards the implementation of CBDCs; the already mentioned DC’s benefits and evolving global finances suggest that CBDCs could become an integral part of a future transformed financial system. Therefore, addressing technological, regulatory, economic and public adoption challenges will be crucial for successful CBDC implementation on a global scale. Most vital element in the process is the reliability of the digital technology!
It is already save to make payments on a blockchain; it is done automatically with full trust; hence, if the software is reliable, the payments could be potentially much more broadly used in presently digital economy; the issue is popularly called “financial inclusion”. In the modern divisions of global workforce, making a remittance deprives a customer about six-eight percent in fees; the EU has already solved the issue alongside other states, e.g. the UK, Hong Kong, Singapore, a number of other countries around the world. Developing reliable and safe digital technologies for private capital is a guarantee that customers’ money would not disappear by any unexpected change in regulation or the damage in infrastructure to make cross-border payments.
However, in international finance, the issue of trading one currency for another world-wide is still based on the US dollar as by far the most dominant trading currency in the world; and it seems to be dominant for decades to come.