World Governments Want to Digitize Your Cash (But Not Right Now)

News and Analysis

People around the crypto space like to talk about the old days. I mean, really old, when people were exchanging pretty shells instead of money. And look at us now: Bitcoins, wire transfers, futures contracts for stuff you’ll never get, and other sorts of financial speculation for rich and poor to enjoy.

Yet, many people’s daily lives are still reliant on small pieces of paper and metal, which sometimes cost more to produce than they can actually buy.

In this feature, we bring up the recent updates on the development of central bank digital currencies (CBDC) and suggest the key conclusions as to how our money will go digital for good.

Lawmaker’s Guide to Digital Cash

In January, the World Economic Forum (WEF) released the Central Bank Digital Currency Policy-Maker Toolkit, which is meant to serve as a “possible framework to ensure that any CBDC deployment fully considers the costs as well as the potential benefits.” 

Primarily, the toolkit is aimed to help central banks decide whether they need a digital currency. The document should also help the banks that are already working on such a currency speed up the development.

“We worked with almost a dozen central banks as well as prominent economists and financial industry leaders to create a common approach for evaluating and designing CBDC around the world,” said Ashley Lannquist, Project Lead at the World Economic Forum.

The document draws a line between CBDC and other virtual currencies, including cryptocurrencies like Bitcoin and stablecoins, which are all “not issued by central banks or typically considered legal tender.” Still, the authors note that central banks’ systems may use blockchain and other DLT technologies with certain considerations.

As to the nature of CBDC, the toolkit describes it as an equivalent of physical cash and central bank reserves:

“CBDC is a new form of digitized sovereign currency, generally conceived to be equal to physical cash or reserves held at the central bank. It is central bank money, or a component of the monetary base and direct liability of the central bank.”

Such currencies would also improve the efficiency and costs of cross-border interbank transactions, reduce counterparty risks, and make the payments more traceable.

2020 State Initiative Updates 

An important update for CBDC came from China. A financial firm Huatai Securities released a report with details about the Digital Currency Electronic Payment (DCEP), a digital currency to be controlled by the People’s Bank of China. 

The central bank will issue the currency and approve transactions, but the public will access the system via approved commercial banks. Functionally, the DCEP should replace physical cash.

“DCEP is a legally encrypted digital currency with unlimited legal compensation. It is a digital form of RMB and its essence is currency. Different from third-party payment platforms such as Alipay, DCEP aims to replace banknotes in circulation,” reads the report.

Similarly to cryptocurrencies, China’s new digital currency is to be protected by cryptography. Information about transactions will be encrypted and the central bank is supposed to be the only entity able to access the full data.

On the Western side, bankers are planning to discuss the development of their own digital currencies. According to Nikkei Asian Review, the heads of central banks of the U.K., Switzerland, Sweden, Canada, Japan, and European Central Bank will meet with the Bank for International Settlements representatives to discuss building CBDC’s as an alternative to Libra and China’s DCEP.

One of their goals is to form standards that will “govern how digital currencies are used to make international payments between the banks.” 

The meeting on CBDC is scheduled for April 2020. An interim report on the working group’s progress is expected in June and a final report should be released sometime in autumn.

“It’s quite natural to consider how to make international transactions more convenient,” said Masazumi Wakatabe, deputy governor of the Bank of Japan.

Notably, the Bank of Japan (BOJ) hasn’t revealed any plans for its own digital currency yet. Although, Japanese lawmakers are suggesting ideas about digital yen. Some officials are concerned by the development of the DCEP and see it as an attempt to establish yuan as a settlement currency in emerging economies.

“The BOJ probably won’t want to do anything that would stifle private-sector innovation. The best way could be to issue a hybrid-type digital currency that is operated and issued by private firms, with the central bank’s involvement,” said Takahide Kiuchi, a former BOJ board member.

The U.S. Federal Reserve is also researching the perspective of building a CBDC. Previously in January, Congress asked the FRS to consider creating a digital dollar. 

“We are concerned that the primacy of the U.S. Dollar could be in long-term jeopardy from the wide adoption of digital fiat currencies. Internationally, the Bank for International Settlements conducted a study that found that over 40 countries around the world have currently developed or are looking into developing a digital currency,” two congressmen wrote In a letter to Federal Reserve Chairman Jerome Powell.

Notably, the Bank for International Settlements’ study mentioned in the letter does say that many central banks are researching CBDC, but it also says that only five central banks have launched pilot projects and “only a few intend to issue a CBDC in the short to medium term.” Moreover, even the most advanced initiatives “are only investigative in nature and do not imply plans to issue a CBDC.”

Key Takeaways

First of all, CBDCs will not be like cryptocurrencies and will be issued, monitored, and controlled by the respective authorities. These currencies do not require a blockchain to work, as the ledger is kept by a centralized entity. CBDCs are meant to replace physical cash and central bank reserves deposited by financial institutions. While cryptocurrencies, at least for some, mean independent money and a certain level of anonymity, CBDCs will give governments a newer better way to monitor transactions and enforce rules.

The actual effect CBDCs may have on cryptocurrencies is yet to be seen, although some experts believe that central banks’ digital currencies will eliminate the demand for crypto altogether. An economist Nouriel “Dr. Doom” Roubini wrote

“If a CBDC were to be issued, it would immediately displace cryptocurrencies, which are not scalable, cheap, secure, or actually decentralized.”

He also argued that the privacy aspect of cryptocurrencies will be easily matched by CBDCs.

Important, although maybe obvious, is the fact that China is the leader in CBDC development. It looks like chief bankers and politicians around the world take the country’s claims seriously, but it might take them a while to catch up with DCEP. As stressed in the CBDC Policy-Maker Toolkit, such a system has significant cybersecurity requirements, as well as economic and legal issues to be solved in each particular case.

In 2020 we will see certain clarification regarding CBDC development in Europe. The U.S. seems to be looking into the matter, but there are no particular details available yet. The Chinese use-case, if it actually plays out well for the CBDC concept, will definitely force others to act, either by giving an example or by being a contender for the role of the dominant currency. Still, as the BIS’ study suggests, only “a few” central banks firmly intend to launch their digital currencies in the next decade.

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