Central bankers warm to digital currencies
The lockdown has seen the use of digital currencies increase significantly around the world. Central banks are getting in on the act. By
Central Banks around the world are researching the idea of introducing digital currencies to effect faster, cheaper and easier transactions. “We must improve existing systems and explore new ones,” said IMF head Kristalina Georgieva in a virtual discussion hosted by the IMF on Central Bank Digital Currencies earlier this week.
While cash is still king, innovation and digitisation are pushing central banks to think about how new central bank digital currencies (CBDCs) could complement or replace traditional money, she said.
“Digitisation has been accelerated by the global lockdowns experienced this year and is now taking central stage in policy making.”
A CBDC is a kind of digital banknote and could satisfy more use cases than paper while the issuer, being a central bank, could support liquidity, settlement finality and trust in the value of the currency. As a result, it could promote payment diversity, help make cross-border payments faster and cheaper, foster financial inclusion and even facilitate fiscal transfers in times of crisis, such as the current Covid-19 pandemic.
Almost 80% of the world’s central banks, particularly in emerging markets, have already started to conceptualise and research the potential for CBDCs, while 40% are building proofs-of-concept and 10% are deploying pilot projects, according to the Bank for International Settlements.
China, for instance, appears to be close to launching its digital yuan, which in recent weeks has seen its biggest public trial.
In the US, the Federal Reserve Bank of Boston is working on a hypothetical CBDC in partnership with the Massachusetts Institute of Technology.
The Central Bank of the Bahamas has officially launched its national digital currency. The first of its kind in the world to have been fully deployed, the sand dollar is a digital version of the Bahamian dollar.
In this case, underserved communities of the Caribbean nation are the primary target of the initiative, which the bank said would reduce financial service delivery costs and boost transactional efficiency.
A report issued by the IMF before the event noted that CBDCs may benefit countries looking to exert greater control over their monetary policy but aren’t a solution for every crisis – high inflation, for instance.
The report said CBDCs should be viewed as another tool in currency issuance or monetary policy, rather than a panacea for every world economy.
Speaking at the IMF event, Jerome Powell, chairman of the US Federal Reserve, said the Fed is committed to considering “the costs and benefits” of a CBDC, but had not yet made a decision on whether to issue a CBDC.
“The dollar is the world’s principle reserve currency. We need to approach the issues carefully,” he said, adding that almost $2-trillion in US banknotes are in circulation and about half that amount, held internationally.
He said central banks have to understand their principal motivations for exploring CBDCs. “Our focus is whether this can improve what is a safe and dynamic domestic payment system. Our population is highly banked and the payment system is evolving fast with digital technologies.
“Any potential CBDC must serve as complement to and not as replacement to the existing system.”
Powell acknowledged that central bankers had been galvanised into action by the founding of the Libra Association in 2019 by
Spotify, Uber, PayPal, Mastercard and Facebook. The project aims to develop a major stablecoin, which is different to a cryptocurrency in that it attempts to peg its market value to some external reference, such as the US dollar or a commodity price such as gold.
Georgieva added that central banks could feel threatened by the possibility of an alternative means of exchange, one that facilitates cross-border payments with serious corporate backing.
In Libra’s case it could be made available to Facebook’s existing 2.45 billion users.
CBDCs are different to decentralised cryptocurrencies like Bitcoin, but they’re both likely to become a key part of the modern financial system. Public awareness is growing about the benefits of using permissionless digital currencies like Bitcoin because intermediaries are not needed to complete transactions between any two parties, regardless of their physical location.
What is limiting the widespread adoption of cryptocurrencies as a general payment method is their volatility and the fact that there is no certainty that the currency can be exchanged into fiat currency at a predictable rate. Central banks are aware of this too.