The digitization of the economy has accelerated amid the Covid-19 pandemic. To keep up with the changes, central banks are investigating and testing central bank digital currencies (CBDC).
A CBDC is a digital representation of fiat currency. At present, only commercial banks can use digital funds. People, companies, non-bank financial intermediaries can make non-cash payments only through their bank accounts. Banks set limits, charge high fees, and are unavailable in some places.
The digital nature of currency is
nothing new. The main point is to make digital money publicly available. The implementation of digital currency can minimize the chain of intermediaries involved in payments to make paying for things cheaper, faster, easier, and more secure.
Benoit Coeuré, the head of the BIS Innovation Hub, believes central banks must accelerate the development of CBDCs. Regulators should create alternatives to private financial instruments as soon as possible since, in the future, the decentralized finance (DeFI) industry and stablecoins will compete with conventional banks. Coeuré notes that central banks risk losing their leading position because cryptocurrencies and stablecoins already exist but developing CBDCs will take years.
Governments have been discussing the introduction of CBDC for some time. According
to a BIS survey, about 80% of regulators were investigating digital currencies by the beginning of 2020, and 40% switched from conceptual research to experiments.
The World Bank reported in April 2020 that about 20% of the central banks were considering launching a digital currency in the next six years.
Central banks want to reduce the impact of cryptocurrency and provide digital currency as a fully legal payment method guaranteed by their respective governments. They also don't always use blockchain technology.
In January 2021, the central banks of Canada, England, Japan, Sweden, Switzerland, the European Central Bank, together with the BIS,
teamed up to share their experiences with implementing digital currencies.
By the middle of this year,
36 central banks had published analytical studies on digital currencies. Three countries have completed testing of the
digital currency (Uruguay, Ukraine, Ecuador), and six more are implementing pilot projects.
Three months ago, the
European Central Bank (ECB) launched a two-year pilot project for the digital euro. The launch of the digital euro will allow it to avoid dependence on digital payment systems controlled outside the Eurozone (such as Visa, Mastercard). Experts from the ECB and the central banks of the Eurozone member states have established several requirements for digital currencies, including availability, reliability, security, efficiency, and confidentiality.
Some experiments show that blockchain can be an efficient framework for managing payments in digital currency. The
Bank of France has paid off digital bonds issued by the European Investment Bank on the Ethereum blockchain using its national digital currency. According to the regulator's statement, this was technically implemented by creating smart contracts in the blockchain to issue and control the circulation of digital euro tokens. The transfer of the CBDC took place simultaneously with the delivery of digital securities to the bank and
investor portfolios. The Bank of France plans to continue experimenting with and evaluate other ways to use the national digital currency in interbank agreements.
China's central bank started to work on
the DCEP in 2014, and in 2020, the authorities began public testing of the digital currency in several cities. China plans to fully start using DCEP by the 2022 Olympic Games in Beijing. Due to the
implementation of blockchain technology, the digital yuan will help prevent money laundering and counterfeiting, illegal financing, and tax evasion. Unlike cryptocurrencies, DCEP is controlled by a single authority rather than a decentralized system run by users around the world.
The use of digital currency will make currency flows transparent and understandable, and the Central Bank’s monetary policy will become more accurate. For China, better economic governance and a more effective competitor to the US dollar is an attractive possibility.
The US is likely to be extremely careful about entering the new digital world. US Federal Reserve Chairman Jerome Powell said that the agency is studying the possibility of creating a fully digital dollar, but this will be possible only with the full support of Congress. Powell says the regulator has just begun to form the concept of a digital dollar and doesn’t plan to undermine the work of the private financial sector.
The former President of the Federal Reserve Bank of Boston,
Eric Rosengren, shared his view in an as yet unpublished research report by the Federal Reserve Bank and the Massachusetts Institute of Technology. He supposes it’s more than likely that the US will implement some form of CBDC, but the initiative might be blocked by bureaucratic protocol. He believes such a CBDC will not be based on any blockchain protocol.
It’s the characteristics they share with cryptocurrencies that arguably bring the biggest benefits to financial regulation and compliance, but also the most concerns. CBDCs could therefore herald, through increased transparency, a new era of improved compliance but at the price of increased surveillance. The digital economy era is bringing us more and more tools and opportunities. It’ll be exciting to see what happens next.
