The Future of Central Bank Digital Currency (CBDC)

Are we ready for nationwide digital currencies?

The recent working paper, of the University of Luxembourg, Postdoctoral Researcher Hossein Nabilou, about the potential legal challenges of issuing a Central Bank Digital currency CBDC, suggests the benefits of cryptocurrencies greatly out way the drawbacks.

Recently, US-based global financial service provider, J.P. Morgan announced the launch of JPM Coin. An internal digital currency for institutional investors to use to wire money in a fast and cost-efficient way. Cross-border payments or remittance has some major drawbacks that can be overcome by using cryptocurrency. The time and operational costs can be strongly reduced. By opting for paying with digital currencies and by implementing them in the safe environment these issues can be overcome.

Global apparel retailer H&M announced they will be accepting cryptocurrencies as a form of payment for their distributors. This global remittance solution is installed to avoid long waiting times for payments to process, and it indicates there is a need for a faster, more cost-efficient international payment option.

At the moment, at least 19 different countries are already experimenting with the idea of a CBDC or they are in the process of further research on the topic. The Republic of the Marshall Islands are creating the Sovereign (SOV), a fully compliant digital currency that will be legal tender on the small Pacific Island. The Swedish central bank, Riksbank, is also pretty far along in doing research on launching the e-Krona, a digital form of the fiat currency the Krona.

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Cashless society

Currency has always gone through changes. The US Dollar, for instance, was introduced as a monetary unit for the US in 1775. First, it was not backed by gold. That changed when the Gold Standard Act was introduced, in 1900. In 1971, President Nixon canceled the international conversion from the US Dollar to gold, making an end to the gold standard. Nowadays the US Dollar is backed by the trust of the nation in the fiat currency.

Times change and technological advancements are driving people towards online and mobile payments, resulting in the decline of cash in circulation. Countries on the Asian continent, like South-Korea, China and Singapore are frontrunning in promoting e-payments over cash payments. The main reason for the Swedish central bank Riksbank to explore issuing a CBDC is also the decline in circulating banknotes and coins.

Central Bank Digital Currency

According to the International Monetary Fund (IMF), a Central Bank Digital Currency (CBDC) is a widely accepted digital form of fiat money that could be legal tender. CBDC will act as a digital representation of a country’s fiat currency and will be backed by a suitable amount of monetary reserves in the form of gold or forex. CBDC will be issued by a country’s official monetary authority, the central bank. In order for a digital currency to become legal tender, formal legislation needs to be adjusted.

The benefits and drawbacks of CBDC are being explored. Some countries have piloted a CBDC, while others are doing extensive research on the topic. Some countries central banks have stated they will not be moving forward in exploring CBDC.

Benefits

Some of the benefits of CBDC include:

Financial inclusion

Financial inclusion is a means to greatly decrease global poverty. In some countries getting access to a bank account can be difficult. According to a research report, in 2017, one-third of the adult world population did not have access to a bank account or mobile payment facilities. Issuing a CBDC means adjusting legislation and stating clear rules on the use of cryptocurrency. If cryptocurrencies are deemed legal, that means that unbanked people with access to the internet can legally transfer funds through a cryptocurrency wallet. They can ask for job payment in cryptocurrency. This can increase financial inclusion and will hopefully bring us closer to the United Nations, 2030 goal of ending poverty in all forms, everywhere.

Cost and time efficient

Wiring a payment to someone in another country can be very costly and time-consuming. Some banks charge a fee per transaction or they calculate a percentage of the total amount. In some cases, it can take days for a payment to clear and to be forwarded to the receiver, especially given the lack of 24/7 operability across banks. Digital currency payments have the ability to be sent almost instantly from a sender to a receiver at a fraction of the cost of a regular (international) bank payment. The implementation of CBDC would facilitate more cost and time efficient settlements of cross-border financial transactions.

Drawbacks

Potential drawbacks to CBDC might be:

CBDC to divert US sanctions

Various countries in dispute with the US, that encountered trade restrictions, are exploring issuing a cryptocurrency. We saw this with Venezuela, that issued the Petro. Iran is working on its own cryptocurrency, according to sources. China has been working on issuing a cryptocurrency. Issuing a digital currency to avoid facing legal sanctions, discredits the reputation of cryptocurrency. US regulators even went so far as to introduce a new bill in Congress that aims to sanction everyone that stimulates or helps Iran create a digital currency.

Bank run

In times of financial turmoil, there is a high probability of people wanting to cash out their bank accounts and obtain physical bank notes. In a digital currency setting, withdrawals might accelerate because of the ease and speed in which customers can complete the transactions. Also, a sudden introduction of CBDC can instigate a bank run, of people wanting to withdraw money for e-money, which can lead to a problem, with banks not having enough cash to fulfill the withdraw orders.

Cross-border implications

When offering a CBDC, will it be accessible to foreigners? If so, this raises questions of whether or not the receiver is Anti-Money Laundering (AML) compliant. Another issue will be transacting with people living in the sanctioned territory.

Fractional-reserve banking

Banks make a lot of money on lending out a large part of their customer’s funds. When the customers opt for CBDC, the banks cannot lend out as many funds, because the money supply in their accounts is less. Because central banks become more invested in the issuing and distribution of ‘money’ they will probably gain more power at the expense of traditional banks. This might lead to instability of the banking sector.

City coins

On a slightly smaller scale, other than central banks exploring CBDC, there are also some city councils that announced the creation of a cryptocurrency. A private city in Norway, Liberstad, announced they are issuing their own cryptocurrency in collaboration with City Chain Labs. City Coin will be the only official form of payment in the privately operated town.

The Austrian capital city of Vienna is issuing The Vienna Token, a digital currency token to incentivize citizens and to give them an option for accelerating tax refunds. The Vienna Token is created in collaboration with the Vienna University of Economics and Business.

Other cities, like Dubai (UAE), Calgary (Canada), Orania (South-Africa) and Naples (Italy) are also exploring cryptocurrency as a form of payment.

Concluding remarks

As I see it, the cryptocurrency industry has already come a long way. Back in 2017, J.P. Morgan CEO, Jamie Dimon, called Bitcoin a scam, and almost two years later the company issued its own cryptocurrency for internal use. J.P. Morgan created their own enterprise-focused blockchain, called Quorum. Large corporations and banks are testing blockchain technology and my guess is we see more and more businesses adopt blockchain technology in various parts of their business model.

In a recent IMF discussion note, called Casting light on Central Bank Digital Currency, the UN organization for collaborating on monetary policies, stated:

‘Overall, it is too early to draw firm conclusions on the net benefits of CBDC. Central banks should consider their specific country circumstances, paying careful attention to the risks and relative merits of alternative solutions. Further analysis of technological feasibility and operational costs is needed.’

This suggests they are not quite ready to approve a CBDC, but they might after further research has been done, or a country comes up with a solid plan for issuing a CBDC.

Disclaimer: I am not being rewarded for writing this article. All the information provided in this article is based on my own personal opinion.

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Linda Willemse