ECB powering ahead on digital currency dossier
The central bank digital currencies (CBDCs) space has been pioneered by a diverse group of countries. Sweden, with its distinctively low use of cash is a natural forerunner but other regions have recently made headway, too.
Notably, the European Central Bank is powering ahead on the digital currency dossier. It not only completed a public consultation on the digital euro, but also a consultation with the European Parliament and made known its plans to start a formal investigation into an e-euro in mid-2021.
CBDCs - a frequently obscure concept that gets lumped in with cryptocurrencies - are a digital representation of central bankissued cash. CBDCs can use an electronic record or digital token to represent the virtual form of a fiat currency in a country/region, backed by monetary reserves.
By their nature, CBDC are centralised, issued by a central bank or akin monetary authority. This contrasts with cryptocurrencies like Bitcoin or Ethereum, which capitalise on the distributed ledger technology known as blockchain and are inherently decentralised and unregulated.
CBDCs strive to combine the technological prowess of crypto, and bring the convenience of the regulated, reserve-backed money circulation of the traditional banking system to an ordinary citizen.
The dynamic progress in the public domain owes to the loss of control over the growth and influence of cryptocurrencies. The starting point can be traced back to Facebook's 2019 plan to launch its own stable coin, Libra.
This was quickly met by an intense pushback from regulators and authorities, ranging from the European Data Protection Supervisor to China's recent regulatory clampdown on payment channels and consumption data.
The rise of cryptocurrencies unleashed a wave of unforeseen financial innovation in the public space. Regulators were quick to neutralise the perceived threat they pose to the institution of monetary sovereignty.
However the onset of the pandemic, with heightened appetite for e-commerce everywhere and greater demand for cashless payments, has provided added impetus for potential CBDC adoption and a means to reign in national monetary control.
One of the key challenges central banks could be faced with in the uptake of digital currencies is the disruptive impact they would have on traditional banking systems.
Digital currencies open the gates for any tech company to become a de facto "bank" (wholesale CBDC) or even sidestep traditional commercial banking completely (retail CBDC). The latter case could yield an unwelcome macroeconomic consequence: if citizens shift a share of deposits to central banks to open e-euro accounts, commercial banks loose resources used to intermediate and finance growth via issuing loans.
This is especially peculiar in the eurozone, where capital markets are shallow and fragmented, and a large chunk of growth is financed via the banking system. Whole CBDC could, thus, be the preferred option that preserves the role of commercial banks as lenders.
Some of its (CBDC) features, such as the built-in programmability for transactions and smart contracts could be regulators' biggest launchpad into the digital economy.