Voice of the Industry

Central Bank Digital Currency (CBDC) – building together the future of money (and humanity)

Monday 2 November 2020 10:46 CET | Editor: Mirela Ciobanu | Voice of the industry

We can do better than build back the pre-pandemic world – we can build forward to a world that is more resilient, sustainable, and inclusive. We must seize this new Bretton Woods momentKristalina Georgieva, IMF Managing Director, Washington, DC on 15th October 2020

The international debate on central bank digital currency (CBDC) is gaining momentum. And as a result, the world has been sieged by CBDC initiatives stemming from all the parts of the world, that aim to digitalise payments, encourage financial inclusion, improve cross border payments, support fiscal transfer, etc. But what is triggering discussions around this topic and why is it important today? Some industry experts say that Central Bank Digital Currencies are coming, and whoever is in denial mood is missing the big and important picture. ‘This is going to be the biggest overhaul of the global financial system since Bretton Woods’. Raoul Pal, Founder/CEO - Global Macro Investor and Real Vision Group

We don’t know yet what will happen, if digital currencies will break through (get adopted and, if they will, when it will happen) but for sure the way we pay today will be massively disrupted in the upcoming period.

Is it Covid-19, payments digitalisation, time to change, Libra, or all?

At the beginning of 2020 no one anticipated how much our life would change due to Covid-19 pandemic and how sticking together to fight it in any possible way has become so important. In March 2020, the public attention focused on CBDCs projects amid fears that the Covid-19 virus might live on banknotes and coins. But, going beyond the impetuous need to avoid the virus and protect the most vulnerable ones (health wise), it has become crucial that nations collaborate to give a helping hand also to those economically vulnerable (people left without a job, SMEs, citizens in underdeveloped/developing countries, immigrants, and many more).

As such, governments and central banks around the world have unleashed unprecedented fiscal and monetary stimulus and other support for economies floored by the coronavirus pandemic. But because many of these people are unbanked, it took longer for the financial aid to reach its destination. At a national level, the use of CBDC would enable governments to directly stimulate the economy down to every citizen through ‘helicopter money’. CBDC could also influence in a positive way cross-border payment, as once CBDC are interoperable, payments can become cheaper, faster, and more secure; it could be just like sending an email.

In recent years there have been already some improvements in local and cross-border payments due to payments digitalisation. As such, the use of cash has started to decline, with many users and merchants embracing digital and innovative ways to transact like cryptocurrencies, tokens, and stablecoins. For instance, PayPal joined the crypto market, enabling users to buy, sell, and hold Bitcoin and other virtual coins using Venmo not only to encourage global use of virtual coins, but also to prepare its network for new digital currencies that may be developed by central banks and corporations.

The announcement that sparked the whole (finance) world and CBDC discussions is by far Facebook’s initiative Libra. Connected to the social media network, Libra has the potential to reach billions of people solving problems like financial inclusion, digital identity, enabling cheaper payments, and more. Facebook has the technology and pockets to develop a global infrastructure that could also be used for digital token exchange, complementing and accelerating the already existing infrastructures of Bitcoin and Ethereum. And of course, CBDC can use this new infrastructure. But it is also a threat to monetary policies, causing financial instability in some parts of the world were people would start adopting the new stablecoin – Libra - instead of their local currency. Not to mention concerns over data privacy related to Facebook’s way of ‘keeping our data safe’.

Digital currency is a political issue as much as a technological issue. At a macro level, the on-going geo-political currency wars have also led national central banks to consider the use of CBDC in international transactions and investments to bypass US’ banking system SWIFT and reduce their dependence on the US dollar. Furthermore, CBDC could be an important adoption element in the evolution of world reserve currency.

In August 2019, Mark Carney, the Governor of the Bank of England at that time, gave a speech in which he stressed the dominance of the US dollar in today’s global monetary system and the need to ‘change the game’. The US dollar’s global hegemonymade sense after World War II, when the US accounted for 28% of global exports. Now, the figure is just 8.8%, according to the IMF. Yet the dollar still dominates international trade’.

In his speech, Carney went on to talk about the idea of a Synthetic Hegemonic Currency (SHC), a digital currency/token, backed by other currencies. An SHC could dampen the domineering influence of the US dollar on global trade, and widespread use of the SHC in international trade and finance would imply that the currencies that compose its basket could gradually be seen as reliable reserve assets, encouraging emerging markets to diversify their holdings of safe assets away from the dollar.

All in all, the economic downturn triggered by Covid-19, fiscal stimulus by governments worldwide, Libra’s introduction, crypto-technologies maturing, citizens seeking refuge for their savings, financial inclusion drive, and of course the on-going geo-political currency wars might propel CBDC into reality.

A new Bretton Woods moment

Central banks are the main providers and distributors of money and credit used as payment mechanisms for trade and commerce. There has been a growing conversation about whether central banks should offer a digital version of cash (CBDC). However, the implications of digital money for monetary policy are not straightforward. If digitalisation means the replacement of cash with central bank derived digital money, then the central bank’s ability to produce inflation will increase because the effective lower bound on interest rates will loosen. However, if digitalisation raises the possibility of the introduction of (private or foreign) competing currencies, the ability of central banks to inflate their currencies would be constrained by the threat of people switching to these competing currencies.

Therefore, there is huge untapped potential with CBDC, but also important risks. Many will say it will take even more freedoms away and in some ways it will. Now, cash allows consumers to transact anonymously in the physical world. As a digital payment system, a CBDC would maintain an electronic history of transactions. However, it also gives those disadvantaged by the lack of available capital a better chance. For instance, the FED offered financial help to US households and small businesses to cope with the financial effects of the pandemic. Disbursed via ACH, check, and debit card, the payments were made relatively quickly to those recipients whose bank account details were available to the government. Recipients without bank accounts had to wait much longer for their relief payments to be disbursed by checks or debit cards through the mail.

As the consumer is in direct contact with the central bank, there will be lots of data generated based on CBDC transactions. As such, CBDCs will push behavioural economics to the forefront based on big data and real time activity data and can create incentives directly as rewards, or punishments. They can also affect human behaviour in a way that is much less blunt than traditional monetary and fiscal policy.

Because central banks oversee their commercial banking system, and by contrast with commercial banks, possess a monopoly on increasing the monetary base in a financial crisis, commercial banks will be challenged greatly, as multi-interest rates set centrally could become the norm. As CBDCs could create a defined cost of capital to whomever they please (if they get the powers by the Governments), banks will no longer get the chance to set interest rates based on capital availability or risks. For example, central banks can give small business owners a direct payment for stimulus whilst, at the same time, charging negative interest rates on larger savers.

Outside of a totally revolutionary way to collect taxes, give incentives, and overhaul the entire monetary system, CBDCs can play an important role in supporting central banks providing funds to the non-bank private sector and, in emerging market economies, towards interventions in domestic currency asset markets, as stressed by the unprecedented crisis caused by the Covid-19 pandemic.

Thus, in line with Deutsche Bank Research recommendations to refresh European economy, Kristalina Georgieva, IMF Managing Director advocates for adopting strong medium-term frameworks for monetary, fiscal and financial policies, as well as reforms to boost trade, competitiveness, and productivity to help create confidence for policy action now while building much-needed resilience for the future.

Overall, there are arguments both in favour and against issuing a CBDC, with design choices that have the potential to be an improvement over existing modes of payment. But for sure, there will be no ‘one size fits all’ CBDC, the Bank for International Settlements (BIS) has assured us, and we should expect more interesting news ahead in the coming year. As developing CBDCs involves many parties, cooperation and coordination are essential to prevent negative international spillovers, while ensuring that much needed improvements to cross-border payments are not overlooked. We must face it: the world is changing, our daily life is changing (has changed a lot since the beginning of 2020), therefore it was absolutely necessary that something happened to the good old ‘euro/dollar/Romanian leu’ bill.

In case you missed the latest instalment of our Central Bank Digital Currency series, on the American Central Bank Digital Currency plan, check out Douwe Lycklama, Innopay’s article here.

Still new to the topic of Central Bank Digital Currencies? We recommend reading Central Bank Digital Currencies for dummies – a quick guide into CBDCs from the Dutch Central Bank, an educational piece written by Harro Boven, Policy Advisor at the Dutch Central Bank.

About Mirela Ciobanu

Mirela Ciobanu is a Senior Editor at The Paypers and has been actively involved in drafting industry reports, carrying out interviews, and writing about innovation in payments and fintech. She is passionate about finding the latest news on AI, crypto, blockchain, DeFi and she is an active advocate of the need to keep our online data/presence protected. Mirela has a bachelor’s degree in English language and holds a master’s degree in Marketing. She can be reached at mirelac@thepaypers.com or via Linkedin.



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Keywords: central bank digital currency, CBDC, Covid-19, payments digitalisation, Libra, cross-border payment, cryptocurrencies, tokens, stablecoins, reserve currency, SWIFT, fiscal stimulus, FED, interest rates, central banks, commercial banks, BIS, IMF
Categories: Blockchain & Cryptocurrencies | Cryptocurrencies
Countries: World
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Blockchain & Cryptocurrencies