The rise in popularity of cryptocurrencies is changing long-held ideas about how money ought to function. Central banks all around the world are beginning to create their own digital currencies in an effort to survive in the long run. According to experts, these new forms of money could increase financial inclusion, reduce transaction costs, and improve the use of money, but they also carry serious concerns.
Since at least a century ago, central banks all had sole authority over the production and distribution of money in the number of developed economies. With the introduction of Bitcoin in 2009, that was put on its head. Using blockchain technology, Bitcoin assigns the minting and governance of the digital money to a decentralised network of volunteers.
Since then, a lot of new cryptocurrencies have appeared, each one offering a fast, inexpensive, and secure means to send money between users without the need of banks or other third parties. The concept of programmable money was also introduced by second-generation cryptocurrencies like Ether, enabling the development of smart contracts which automate the implementation of financial agreements.
Since the government already has these capabilities over your existing bank accounts, we must be very careful to avoid giving superpowers to central bank digital currencies. —Rich Turrin, author and expert in fintech
However, the underlying technology has prompted a fundamental rethinking of what money should look like in the digital era. Volatile prices and regulatory uncertainties have prevented their widespread acceptance as a practical form of payment. According to Andreas Veneris, a professor of computer engineering at the University of Toronto who has counselled the Bank of Canada on digital currencies, “they established that there may be a new way to organise money and make payments, and that this can be broadly adopted.”
Now, countries across the world are creating digital versions of their national currencies by stealing strategies from the cryptocurrency industry. Chinese research on digital currencies began in 2014, and in late 2019 it began testing its digital yuan in four locations. China has long been the world leader in this area.
However, the Bahamas became the first nation to introduce a central bank digital currency (CBDC) on a national scale in October 2020. Since then, digital versions of the Jamaican dollar, the East Caribbean dollar, and the naira of Nigeria have all been introduced. The U.S. Treasury Department was ordered by the Biden administration to look into the idea of a digital dollar in March, and the Atlantic Council reports that more than 50 nations are actively monitoring CBDCs.
According to Veneris, one of the main drivers is to increase the efficiency, speed, and flexibility of digital payments. Noting that much of the technology involved is over 40 years old, he argues, “Payment systems today are expensive; they are inefficient and slow.” Similar to cryptocurrencies, CBDCs may enable instantaneous money transfers between individuals without the need for intermediaries, leading to less expensive and quicker payments.
By providing direct cash transfers to people despite of if they have a bank account, they could also try to offer new prospects for reimagining social welfare and financial inclusion, according to Veneris. Using smart contracts, it may be feasible to limit the use of welfare money to allowed things like food and medication.
Too far, the largest-scale CBDC experiment has been China’s digital yuan. By the end of the previous year, 23 cities had joined the project. The People’s Bank of China reported that 261 million wallets had been opened and that there had been 87.6 billion yuan in total transactions (PBOC). With 83 billion yuan in total transactions in the first five months of 2022, use accelerated. According to Rich Turrin, a fintech consultant based in Shanghai and the author of Cashless: China’s Digital Currency Revolution, more CBDCs are expected to adopt a similar model, thus it also makes for a fascinating case study. Because of the function they are intended to do, “most of them are going to appear very similar,” he says.
According to Turrin, the government’s reaction to an economy digitising much more quickly than that of other affluent nations is the digital yuan. Online sales made up 52% of retail transactions in China last year, relative to 13% in the US. According to Turrin, the currency aims to promote this digital economy, increase financial inclusion among digital outsiders, and provide as a backup system in the case that the top private payment providers WeChat and Alipay go down. The barrier between the central bank, the banking system, your wallet, and your money is a benefit, not a flaw, said Dante Disparte from Circle.
The coin is kept on an electronic wallet created by the PBOC or the WeChat app as a digital token. It can also be kept on payment cards with innovative designs that enable offline transfers for people without cellphones. A user must authenticate their identification with a bank, which keeps records of who owns the wallet, in order to open a wallet. According to Turrin, individuals can transfer money anonymously to another person’s wallet for lower-value transactions by just linking their phones. Similar to how cryptocurrencies do it, the digital tokens store a cryptographically secured record of transactions to make sure transfers can’t be faked.
The wallet must connect to a centralised government system that conducts fraud and anti-money-laundering checks and retains a record of the transaction for transactions exceeding around US $300. If there is suspicion of criminal activity, the government may request a warrant to make banks to disclose the names of persons who participated in transactions.
There have been concerns that CBDCs like the digital yuan, which encourage depositors to transfer their money into safer, central bank-backed wallets, could weaken the private banking system. This is doubtful, however, according to Turrin, because of the digital yuan’s design, which excludes the possibility of interest and puts a limit on the amount that users can send.
Who wants to make a bet on society that the aggregate of all that retail economic activity won’t be used one day for ill?” said Dante Disparte, Circle.
Dante Disparte, chief strategy officer of Circle, the company that created the USDC stablecoin with a set value to the dollar, claims that this raises concerns about whether central banks are acting beyond of their authority when it comes to CBDCs. Making low-level decisions on how citizens use their money is far outside of a central bank’s key competences, according to him. The fundamental role of a central bank is to assure sustainable economic growth by managing the money supply, he claims.
“You stopped being a central bank and started being a high street bank if you’re adopting micro-level, digital-wallet-level retail payments policy,” claims Disparte. It’s a feature, not a bug, that there is a gap between the central bank, the banking system, your wallet, and your money.
Disparte argues that it would be unwise to count on public-sector organisations to make the best decisions on the future of digital payments considering their past history with digital transformation. He continues by saying that a centralised CBDC has significant cybersecurity and obsolescence risks, and that if it becomes the predominant electronic money standard, individuals will have few options if it fails.
And regardless of how strong precautions are around CBDCs, according to Disparte, completely traceable digital currency might end up being too fascinating of a tool for the authorities. Who wants to take on society that the collection of all that retail economic activity won’t eventually be used for ill?, he asks.
Veneris questions whether customers should feel any better about having faith their financial history to the private sector in light of high-profile cases of big tech companies misusing user data. However, he acknowledges that a CBDC has the potential to provide governments new levels of power over citizens.
However, one of the merits of the cryptographic fundamentals that support digital currencies is the capacity to audited and verifiable regulations into their operation. This programmability opens the door to the possibility of directly implementing financial regulations into digital currencies in order to safeguard citizens and stop criminal activity, allowing for easy direct public oversight.
He says, “I can prove to you that the code is valid and that, cryptographically, it represents what I told you it represents. The CBDCs will always be a little slower if all these cryptographic concepts are used, but it’ll be more fair.”
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