Central Banks Enter Brave New Worlds of Crypto

Digital currencies are all the rage these days and central banks are not immune to their charm.

There were more than 7,500 cryptocurrencies by the end of 2021, from around 66 in 2013, and while most are unlikely to survive, they have sowed the seeds of the popularity of digital currencies.

Central banks, which had earlier warned about the dangers of cryptocurrencies, are intrigued by the underlying technologies of the currencies and see it as one of the many forms of money in the future.

Central banks’ involvement and oversight are important as there is a danger that large corporations will start to dominate financial payments that could lead to security and sovereignty issues and could threaten their own monetary policies. For these reasons, governments across the world want their central banks remain the monetary anchor for payment.

The idea that central banks would issue digital forms of money for general use is a natural progression from the issuance of physical cash, according to the Bank of International Settlements, which is an umbrella body of the world’s central banks. While banks have also had access to digital forms of central bank money for several decades in the wholesale payment system.

“However, the debate on the issuance of digital central money that is accessible to ordinary users has picked up pace only recently,” BIS said in a report published in late 2021.

“CBDCs can be seen as a digital extension of the existing forms of central bank money, namely cash (bills and coins) and central bank settlement accounts,” BIS noted. “As a digital liability of the central bank, wholesale CBDCs could become a new instrument for settlement between financial institutions. Retail (or general purpose) CBDCs would be a central bank liability, a form of “digital cash” accessible to all.”

The central banks of the UAE and Saudi Arabia also teamed up in 2020 to present a report on a joint digital currency and distributed ledger proof of concept project.

“Project Aber was an initiative launched by the central banks of Saudi Arabia and United Arab Emirates to explore the viability of a single dual-issued digital currency as an instrument of domestic and cross-border settlement between the two countries,” according to a report published in 2020.

The central banks reported that the experiment was successful in meeting its objectives, demonstrated possible incremental benefits of this new approach to payments, identified important lessons learned that can benefit other central banks exploring the field, and has identified several areas of future expansion that can be considered by either the participants in this project or other central banks.

“As such, we believe this project has made a material impact on industry understanding of the field and is a substantial contribution to the body of knowledge in how the emerging technology of DLT can be applied to cross-border and domestic payments,” the two banks said.

The U.S.-based non-profit Digital Dollar Project also launched five private-sector pilot programs over the next year to test the potential uses of a U.S. central bank digital currency, said to be the first effort of its kind in the United States.

China is also experimenting with a pilot project worth 100 million digital yuan in nine cities, which has now recorded 500 million transactions with 140 million users.

The Asian country plans to roll out E-yuan during the Winter Olympics in 2022.

IMPACT OF CBDC

What will be the practical uses of CBDC if it enters the mainstream?

First, it will lead to greater competition, as new fintech companies will be able to compete with established banks.

“CBDC will also facilitate the entry of new players from fintech, because the brand reputation of established banks as safe custodians of people’s money will no longer be a barrier to entry – nor will their networks of branches and paper cash outlets,” according to the Harvard Business Review.

Central banks’ involvement in digital currency will also ensure the privacy of consumers – which has emerged as a major consumer complaint against fintech companies.

“For consumers, the digital euro would offer a cost-free and convenient way to pay digitally anywhere in the euro area,” according to Fabio Panetta, member of the executive board of the European Central Bank. “It would also increase privacy in digital payments: as a public and independent institution, the ECB (European Central Bank) has no interest in monetising users’ payment data and it could only process them to the extent necessary for the functions of the digital euro, in full compliance with public interest objectives and EU legislation.”

The new digital currencies backed by central banks would also be more financial inclusive, especially in the Middle East North Africa where a number of people remain unbanked. Indeed, Morocco and Egypt are among the six countries with the highest unbanked population anywhere in the world.

It will take a few more years for central bank digital currencies to gear up, but one analyst expects CBDC to be a natural progression of fiat currency,” according to Ajay Mookerjee, a senior fintech adviser to Warburg Pincus.

“In my view, the move to low or no-cash economies based on CBDCs, whose sovereign monetary bodies compete on software-like features and costs, is inevitable,” Mookerjee concluded. ©