Declining use of cash is pushing central banks to develop digital currencies
Central banks are accelerating their way around digital currencies, and investors are taking note.
Earlier this year, the Bank for International Settlements (BIS) released its latest study showing that 86% of the 65 central banks in the world it spoke to were working on some form of "central bank digital currency" (CBDC), be it research, proof of concept or pilot development.
Almost 15% of them are doing research for pilot projects.
Deputy Governor of the Bank of Italy Piero Cipollone told CNBC that the increased focus on CBDC stems from a general move away from cash, adding that «it could undermine one of the core functions of the central bank».
He said that «in an environment where cash is used less and less by both buyer and seller because the whole ecosystem is shifting towards (becoming) digital … you want to replace the functionality of cash with something digital, but conceptually striving to be as close as possible to cash».
Benoit Coeur, a former member of the European Central Bank and now the head of the BIS Innovation Hub shares this view, saying that it is necessary to think of CBDC as a form of banknotes, adding that it is «a means of receiving money issued by central banks in a new modern infrastructure».
However, reduced use of cash may not be the only reason.
Grant Wilson, The head of Asia-Pacific strategy agency Exante Data, told CNBC that much of CBDC’s research accelerated when Facebook got involved in a stablecoin project called Libra (now known as Diem), which could have potential systemic implications for the financial system..
He explained that at this point, central bankers began to realize that they were in some danger, which became clear after the announcement of the development of Libra..
Central bank digital currencies will benefit from much of the same technology as private cryptocurrencies, enabling instant payments, faster settlement and lower transaction costs, especially for international payments..
They can also be a means of ensuring financial inclusion, reaching out to those parts of the population that are not covered by banking services. But, unlike private cryptocurrencies, CBDCs will be centralized, and each unit of digital currency will have the same value as one currency..
There is no consensus on how the CBDCs will be released. The two main forms studied are wholesale (CBDC, issued only for financial institutions and for financial architecture) or retail, that is, digital currencies available to the general public..
Similar to how central bank money is printed and distributed through a commercial banking system, one of the popular methods of issuing CBDCs is «two-level» a system in which the central bank issues a token that will be transferred to commercial banks for distribution. Each transaction will be recorded in the digital ledger of the central bank, but the money will be held in a commercial bank in a digital wallet unique to each user..
One concern is that the rise in CBDCs could inadvertently trigger bank exodus if users choose to ditch bank deposits (which are a commercial bank’s obligation) in favor of the relative safety of a central bank-issued currency..
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Cipollone says one way to avoid this is to get CBDC interest rates above a certain threshold. In theory, this also means that central banks can pass negative interest rates directly to the consumer, rather than through commercial banks..
Analysts were quick to speculate that the emergence of the CBDC could have implications for monetary policy, but Benoit Coeur warns that «so far central banks have dealt with this issue as part of their payments discussion».
«Discussion of the monetary component will take place at some point. We are still in the early stages of specifications / sustainability for it to work», – he told CNBC.
China has advanced the farthest in the development of CBDC, in 2020 one of the forms of the electronic yuan has already been tested here. However, the motivation there may be different..
Wilson notes that «e-yuan will still be integrated with commercial banks, but this is a direct challenge to tech companies (such as WeChat Pay and Alipay) that they will try to eventually supplant».
«Perhaps this is a way to make people look at the yuan differently and undermine the dollar’s hegemony.», – he said.
Coeur said that coordination between central banks is very important. «CBDC is a national project … and ultimately the decision will be made at the national level. But we have an international monetary system, and we don’t want CBDCs to prevent the system from adjusting through free exchange rates or capital flows.», – he said, concluding that «IMF and BIS are working on it».