Category: World

17- Jun2021
Posted By: fiezie92
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Why are central banks interested in digital currency

What began as speculation and the subject of debates by financial experts and institutions is fast becoming a model that central banks are now embracing. Central banks are now considering digital currency as a cryptocurrency alternative.

No doubt the exponential increase of Bitcoin price since its inception in 2009 is a big reason why central banks are now working towards developing their own cryptocurrency.

It is important to also acknowledge that cryptocurrency has continued to grow in strength. This is even with the fact that central banks initially disparaged it and gave it bad publicity. China even went as far as barring banks from using it.

We also had famous economist Paul Krugman calling it evil.

But today we have more than 85% of central banks around the world working on the digital versions of their respective currencies according to PwC.

A question that comes to mind is the difference between conventional digital currencies and central bank-issued digital currencies. The main difference is that cryptocurrencies rely on distributors like blockchain while digital currencies will be issued like banknotes by central banks.

So maybe the whole thing is about wrestling back control to the Government. I’ll explain this later.

Why Digital Currency?

Why have central banks all around the world suddenly made a U-turn on their stance on cryptocurrency? Why are working groups being set up to discuss the merits of Central Bank Digital Currency (CBDC)? Could it be because of its popularity or price increase around the globe?

The answer to that question is both. Stay with me as I shed more light on this.

China was one of the first countries to bar the use of cryptocurrency but it is also leading the race for its own digital currency. In fact, they have been researching this initiative since 2014. They have also issued more than $300 million worth of digital renminbi into their economy. Digital Renminbi (RMB) is China’s digital currency and is the first by a major economy. Trials have even been carried out in cities like Shenzhen, Chengdu and Hangzhou.

Christopher Giancarlo, the previous chairman of the U.S. Commodity Futures Trading Commission had some really interesting things to say about RMB. According to him, people will use digital RMB as a payment option for shopping, buying meals and staying in hotels by Winter Olympics in 2022.

Other countries have taken note of the strides China has made in their digital currency experiment. They are also now open to the possibilities but many are playing catch up.

Bank of England released a roadmap to a digital pound sterling. According to the bank’s chief economist, Andy Haldane, the move can help the UK’s COVID-stricken economy by benefiting from negative interest rates.

The US has also started talking about the possibilities of a digital dollar. This was in part due to the actions of commercial banks. Leading banks like JP Morgan already employed the use of cryptocurrencies for cross-border payments and settlement.

Sweden is in a race to be the first cashless nation by 2023 and is lining up its own digital currency named ‘e-krona’.

Recently, El Salvador’s president announced his plan to make Bitcoin currency a legal tender in the country.

Why The Cryptocurrency Scare?

Two factors seem to be pushing world powers to adopt their own digital currency. The first is the need for a global regulator to lay down the law in the expansive cryptocurrency world. The second is to prevent rogue players from doing it first.

We already countries like Venezuela and North Korea pushing digital currency agendas. North Korea has already launched Petro, their digital currency, as a means to bypass US sanctions.

Other factors influencing digital currency momentum is the promotion of financial inclusion, easier cross-border transactions and payment system stability.

It would come as a surprise that Bitcoin isn’t the main threat to central banks. Even with its $2.2 trillion worth. This is because BTC is very volatile and the blockchain network is slow.

Stablecoins is what central banks are most worried about. This is because they are digital currencies backed by stable assets like gold.

A CBDC backed by gold is already being considered by the Russian government.

Financial and technology companies have also started looking at the possibility of integrating stablecoins into their platforms.

The most popular and largest stablecoins at the moment is Tether. It has about $51 billion worth in circulation.

Adding to this is the potential competition launch of the Facebook backed stablecoins, Diem. It has also garnered support from Uber and other companies.

Why are stablecoins feared? Well, it’s really simple. We know by now that people hold BTC as a store of value. Now imagine when people do that and start transacting more in stablecoins. What we are looking at is a rapid fracture of money and payment systems.

This is why central banks and governments are looking at the options of digital currency. It is so they do not lose control of their monetary policies. Without monetary control, they can’t monitor inflation and financial stability.

People and businesses can also benefit socially and economically from digital currencies. More effective monetary policies, lower transaction fees for businesses and consumers and potential reach to bankless people are some benefits.

Economic policies like stimulus checks can also be targeted more properly through CBDC. Since digital currencies are programmable, stimulus checks can have a deadline. This way you have to spend before it vanishes and it will help boost the economy.

CBDC can also potentially help reduce money laundering and similar illegal activities.

Privately issued digital money can’t be stopped but CBDC can help level the playing field.

Challenges of Digital Currency

Technological issues apart, there are some concerns that digital currency would have to overcome. Such an example is a privacy concern. Since its government-owned, CBDC could make it easier to spy on private transactions.

Another challenge is how to please commercial banks. This is because by adopting a digital currency, central banks would be in direct competition with banks for deposits. This can cost them interest income on assets and raise funding costs. Compensating banks for CBDN services is a proposal that has been received to address this concern.

Datastream and client relationships are important for banks to sell financial services to generate revenue. This can be disrupted by the CBDC.

Some central banks are however working to limit consumer holdings of digital currency. ECB for example is contemplating a consumer holding of between 3000 euros to 3600 euros.

Banks can also employ the use of CBDC.

Conclusion

Cryptocurrency is growing in popularity and will continue to do so. Bitcoin especially has shown tremendous value increase over the years. Add the emergence of stablecoins then it is understandable why central banks have taken note.

It isn’t about wanting a slice of the cake. It is more about levelling the playing field and being able to monitor and exert control by the government.

Having a digital currency is a good prospect for most countries. But that is open to the concern of if they can get it right. With China leading the charge, it won’t be long before other major economies jealously accelerate their own development.

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