The race to replace cash with crypto is hotting up
Worried by crypto’s ascent, central banks are designing official digital money. But what’s the need for it?
When Hurricane Dorian swept across the northern Bahamas in September 2019 it left a trail of what the country’s prime minister Hubert Minnis called “generational devastation” in its wake. Buildings were flattened, scores of people lost their lives and, in addition to water and electricity supplies being cut off, banks were destroyed. Though they had their lives to rebuild, the archipelago’s residents were left with no access to cash.
In some cases restoring bank branches and ATMs took months to achieve, prompting the Central Bank of the Bahamas to accelerate the launch of a “storm-proof” mobile-phone-based digital currency. The Sand Dollar, which went live in October last year, became the world’s first central bank digital currency (CDBC), allowing Bahamian citizens to electronically send and receive money without the need for a bank account. Like commercial cryptocurrencies such as Bitcoin and Ethereum, the Sand Dollar works using blockchain technology, meaning transactions are transparent, recorded and secure. Unlike commercial cryptocurrencies, which are decentralised and regulation-free, it is issued and controlled by the country’s central bank. That means, with the state guaranteeing the value of the money, it offers both the monetary stability of physical cash and the convenience and security of crypto. Or, put simply, it is a digital version of the bank’s coins and notes.
With the use of physical cash dwindling, particularly after a year of lockdowns, it is an example many other countries are keen to follow. In its CBDC Global Index, consultancy firm PwC reports that more than 60 central banks have been looking into CDBCs since 2014, with a small number having already entered the implementation stage. The Bank of Japan has started a one-year trial of its digital yen, while the People’s Bank of China has trialled its digital yuan in cities including Shenzhen, Chengdu and Suzhou. Plans are afoot to allow visitors to use the digital yuan at the 2022 Beijing Winter Olympics.
In Europe, efforts are less advanced. The European Central Bank last year issued what it called a “comprehensive report” into the potential for a digital euro, but its President Christine Lagarde said last month it would take at least another four years to reach fruition, if it ever launches at all. In the UK, an HM Treasury and Bank of England CBDC task force was launched this week to assess the “benefits, risks and practicalities” of creating a so-called Britcoin, with a key element of their work being to identify whether there is a “use case” for such a thing.
Even Sweden, which has been at the vanguard of digital currency development in Europe, has yet to decide whether to press ahead. Its central bank, Riksbank, began assessing the viability of an e-krona in 2017 after voicing concerns about what it called the potential for the “marginalisation of cash”. It has run a number of pilots using R3’s Corda technology and digital wallets installed on phones, smartwatches and payment cards, but said in a report issued this month that “there has so far been no decision on whether to issue an e-krona or on how the e-krona would be designed and which technology would be used.
For author David Gerard, whose books Attack of the 50 Foot Blockchain and Libra Shrugged investigate the role cryptocurrencies play in the financial system, what these projects lack is the key element the Bahamian one had: a pressing reason for a digital currency to exist. “I like the Bahamas’ digital currency because they started from the position of ‘we have a problem, how do we solve it’,” he says. “Their problem was that the outer islands didn’t have good banking access so the central bank stepped in. It’s supplying a form of money that can be used in those islands and can be used offline. They made it possible to transmit small amounts by phone so it’s just like handing someone a five-dollar note. If you look at the European Central Bank, they are not solving a problem.”
In that context, it is perhaps unsurprising that the PwC report found that CBDC projects are most advanced in emerging economies. The organisation noted that, after the Bahamas and Cambodia – whose CBDC, bakong, launched at the end of last year – Ukraine, Uruguay, Ecuador and Turkey are at the forefront of digital currency development. Like Cambodia, where just 22 per cent of adults have a bank account, according to the World Bank’s Global Findex database, each of these countries has a large unbanked population. Also like Cambodia, where there are 1.28 mobile phones per adult, they have high mobile utilisation rates. Facilitating financial inclusion has therefore been one of the key drivers of their CBDC programmes. As PwC partner Pauline Adam-Kalfon says, CBDCs both “modernise the current monetary system, but also help to bridge the gap with the unbanked”.
Modernising the banking system is an obvious benefit of CBDCs, and the Bank of England has made it clear that keeping pace with the digital economy is a key driver of its own potential plans. But there is some scepticism about whether it would serve a wider need in western democracies with mature banking systems. Problems with financial inclusion are not limited to developing markets – research from the Financial Conduct Authority estimated that 1.3 million UK adults were unbanked in 2019. Yet the maturity of these systems means some solutions are already being provided. Basic bank accounts, for example, which are mandated by the UK government, are accessible to those with poor credit histories, while challenger banks including Revolut and Monzo do not usually ask potential customers for proof of address in order to open an account. Gerard says that weakens the case for creating a CBDC in these kinds of economies. “There’s a difference between interesting, not impossible and actually useful,” Gerard says. “Not impossible is not a high bar to clear, but actually useful is harder to make work.”
For Eloisa Marchesoni, co-founder of blockchain consultancy Blackchain International, being useful is not a top priority for central banks. She believes banks are all jumping on the CBDC bandwagon for political reasons. There are concerns that China’s ruling Communist Party could use its digital yuan to expand the mass surveillance of its citizens even further. But it is because of the potential role China’s CBDC could play in Africa that Marchesoni believes other powers will seek to emulate it. “China has already won the 5G race and is winning the CBDC race as well – that will affect the geopolitics of the world,” she says.
Just like the other countries that are at an advanced stage of CDBC development, much of the African continent is underbanked but is well served by mobile phones. China, which has made significant investments across Africa via its Belt and Road Initiative, is a major exporter of mobile phones to the continent, with Transsion brands Tecno, Itel, and Infinix accounting for almost 50 per cent of the African mobile phone market. Huawei’s latest phone has an inbuilt digital e-yuan wallet; if other manufacturers follow suit China will be well placed to export its digital currency to a region in which use of the yuan is already posing a threat to the dominance of the US dollar. While the dollar has been the reserve currency of the world since the Bretton Woods Agreement was signed in 1944, several African countries have been toying with the idea of additionally adopting the yuan for the past couple of years. Unsurprisingly, the US Federal Reserve is now looking at the possibility of creating an e-dollar, although its project is at a very early stage.
Geopolitics aside, Caroline Stevenson, head of the financial services regulatory team at law firm Burness Paull, says that much of the interest in CBDCs revolves around governments wanting to retain control over monetary systems they fear are ripe for disruption by commercial cryptocurrency providers, and projects such as Facebook’s proposed cryptocurrency Diem (erstwhile Libra), to be launched at some point this year. A class of cryptocurrencies called stablecoins – of which Diem would be an example – is of particular concern, as they allow for quick payments with no or trifling transaction fees, and are shielded from the price volatility that characterises cryptocurrencies like Bitcoin. States need to find ways to compete, or risk witnessing private currencies erode their monetary policy.
“At the moment central banks have a huge monopoly over the issuance of currency: they effectively determine how many pounds and pennies are floating about,” she says. “The fact there’s a whole new type of payment has the potential to disrupt the system. That’s forced central banks’ hands to really look at this and take it seriously.”
Yet if Sweden’s example is anything to go by, it will be some time before the world is awash with digital currencies that function like cash and protect the integrity of the financial system. In its report, Sweden’s Riksbank notes that while testing of its e-krona shows that a solution based on blockchain technology is possible, it also needs further investigation. In particular, the first phase of the project was too small in scope to establish whether the technology could “manage retail payments on a large scale” while work needs to be done to analyse “to what extent the information stored in the transaction history can be regarded as information covered by banking secrecy and whether it comprises personal data”.
Societies are becoming increasingly cashless – particularly in the wake of the pandemic – and CBDCs might complement, rather than replace, physical cash in the system. “I think eventually it probably will replace cash [completely], but that’s centuries away,” says Stevenson. “Everyone is looking at it and that creates a domino effect. But it will take a while because [regulators and central banks] want to make it safe and get it right. It’s going to be in tandem to pounds and pence.”
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