Despite their recent extreme fluctuations, The rapid rise of cryptocurrencies has left many of the world’s central banks scurrying to set the record straight on their interest in creating their own digital currency. Some are more committed than others – so what are the pros and cons, and will we really see countries swapping their currency for crypto?
In August 2021, Chinese archaeologists announced that they had discovered the world’s oldest known and securely dated coin-minting site. It’s thought that it was here, in Guanzhuang, that the first standardised metal coinage was produced sometime around 640BC.
Money has, in some form or another, been part of human history for at least the past 5,000 years. And during that time, we’ve seen the system metamorphosise from metal to paper and to plastic. But what does the future hold?
As we increasingly pay digitally and shop using tech, we rely less on cash, with our wallets gradually moving from our pockets to our smartphones and other electronic devices.
These changes are, of course, having profound implications for the nature of money itself, raising the question of whether central banks should issue digital currencies for retail use.
Central bank digital currencies (CBDCs) are digital tokens, similar to cryptocurrency, issued by a central bank. Like traditional fiat currencies, CBDCs give holders a direct claim on the central bank, allowing businesses and individuals to make electronic payments and transfers.
They bring some of the apparent upsides of private digital currencies to the world of public money, and should therefore be safe in times of financial crisis.
Snowballing interest
In March this year, 87 countries were considering issuing a CBDC. Of those, nine – the Bahamas, Nigeria and seven in the Eastern Caribbean Currency Union – have already launched a centrally governed digital currency.
Two years ago, however, a mere 35 countries were thinking of issuing a CBDC. So, what has prompted so many to start taking them seriously?
There are two main drivers: fears over private companies outstripping regulators’ powers; and geopolitical concerns.
The former is linked to stablecoins, which have seen a huge surge in popularity over the past few years. Stablecoins are a form of digital currency that bridges the worlds of crypto and everyday fiat currency.
Their prices are pegged to a reserve asset, such as the US dollar or gold, which means that when compared with the likes of Bitcoin, they are much less volatile.
But regulators are uneasy about stablecoins. Speaking at the annual European Central Bank Forum on Central Banking last year, US Federal Reserve Chair Jerome Powell said stablecoins could represent a certain threat to the financial system because they “exist mostly outside of the regulatory perimeter”.
He added that the tokens are a source of concern for monetary policymakers.
In terms of geopolitics, China was among the first nations to explore CBDCs, starting more than a decade ago. As such, it could start to shape the standards that govern this financial transformation, which could have huge implications for the likes of data privacy and security.
Perks and pitfalls
Many people are of the opinion that an effective CBDC could reduce consumers’ desire to rely on stablecoins.
Advocates also believe they would provide a more resilient payments landscape, support radical competition to the big tech monopoly, ensure access to legal tender if cash is unavailable and offer faster and stronger cross-border payments.
Crucially, CBDCs almost always work in favour of financial inclusion by allowing easy access to a system that is low in cost yet efficient.
There are, however, apprehensions around CBDCs. One worry is how CBDC adoption could impact traditional financial institutions. If CBDCs are safe havens in times of economic instability, people could quickly remove funds from traditional banks, thus creating runs.
Question of control
Control is another area of concern. Critics voiced fears that the deployment of China’s digital yuan project (e-CNY) would allow the Chinese government to block shoppers from using the coin at stores that fell foul of their policies.
Mass surveillance could be another problem.Some people disagree with the idea that CBDCs will promote financial inclusion, arguing they may remain out of reach for those with dated or no devices, further depriving those already on the margins of society such as the elderly or vulnerable.
Progress is being made in this space, and it looks inevitable that despite concerns, and owing to their success in certain parts of the world, CBDCs are set to be an integral part of our financial future.
Not least, this is because consumers will likely demand it. And consumers inevitably get what they want.
CBDC progress around the world
US
In March, US President Joe Biden issued his highly anticipated executive order on digital assets, a space in which he wants the US to lead. “The United States must maintain technological leadership in this rapidly growing space, supporting innovation while mitigating the risks for consumers, businesses, the broader financial system and the climate,” the White House said.
China
Despite still being in the pilot phase, the digital yuan – officially known as the e-CNY – has been tested in around a dozen regions and by late 2021 had around 140 million individual users – about one-tenth of the population. More than 1.5 million merchants accept the e-CNY, too. Its goal is to allow more people in rural areas to enjoy digital payments, to provide a backup to private platforms and make the payment system more efficient. China is taking a measured approach in its promotion, however, and still faces overseas scrutiny and criticism over the possibility that the government may track users’ transactions.
Bahamas
The Bahamas became a global leader when it launched one of the world’s first central bank digital currencies – the Sand Dollar. The Sand Dollar holds the same legal status as the standard currency, is issued by authorised financial institutions, and can be used for a variety of transactions. Part of its purpose was to help improve financial inclusion – 20% of the population is estimated to not have a bank account owing to a lack of physical banks – and strengthen security against money laundering and other illicit economic activities.
Europe
In July 2021, the European Central Bank announced plans for a 24-month investigation phase towards a digital euro project, which commenced in October and will include design and distribution options, impact on markets, and required changes to EU regulations. Subsequently, work on the prototype is likely to begin at the end of 2023.
Meanwhile, in the UK, the Bank of England and the Treasury set up a joint CBDC taskforce in April 2021 to work with other UK authorities in reviewing the potential for a digital pound. But at present, there isn’t huge amounts of enthusiasm behind the notion.
India
India’s CBDC project was announced in February and is looking to launch in the 2022/23 fiscal year. According to Finance Minister Nirmala Sitharaman, an electronic representation of India’s legal tender will give a big boost to its digital economy. Some have suggested, however, that the digital rupee needs more thought and less haste.