Could digital currencies put banks out of business?
When cryptocurrencies emerged just over a decade ago, the talk was of a decentralized utopia – a way of moving money around that avoided the usual middlemen. Today things are moving in a very different direction. Around the world, central banks are racing to create their own versions of digital money. And nowhere is this happening faster than in China. This is going to happen. And those countries that trial it and test it early will be in an advantageous position. One very obvious negative element or motivation is the application of surveillance and monitoring.
We think this is a global race and we cannot afford not to be part of this effort. How the rise of cryptocurrencies like Bitcoin triggered a radical rethink about what money actually is, and who controls it. – How central bank digital currencies – or CBDCs – could disrupt existing power dynamics in the financial system – and what all this could mean for you – the consumer. But first – some background:
You’ve heard of Bitcoin, Ether, Dogecoin and the like. These are cryptocurrencies – designed to allow you to pay for stuff without any government or bank being involved. They’re based on blockchain technology. A kind of digital ledger that records transactions in a chain. It’s hard to tamper with because doing so leaves a trace elsewhere – potentially for everyone to see. That transparency is one of its most promising features.
In the past year, backing from high-profile figures like Elon Musk as well as established payment companies like Visa and Mastercard have given Bitcoin in particular a massive boost – sending its value shooting up, but often swiftly back down again. The rapid rise of cryptocurrencies initially left governments and regulators scrambling to respond: People were worried and they didn’t understand that the actual technology of blockchain was an amazing way to remove intermediation.
Meanwhile, the private sector was spotting an opportunity. In 2019, none other than facebook arrived on the scene – promising to create its own version of digital money that wasn’t volatile, like Bitcoin. “I believe it should be as easy to send money to someone as it is to send a photo.” The plan: a so-called “stable coin” whose value would be pegged to a bunch of established currencies. The project originally known as “Libra” and since renamed “Diem,” raised a lot of eyebrows:
Most central banks were really scared when they heard about this project. They thought it would be a new asset that would be adopted by two billion people and it will compete with our domestic money.” The idea of a giant tech company becoming a big player in the global financial system wasn’t the only issue governments had with cryptocurrencies. They were also worried about how widespread adoption could affect their ability to implement monetary policy.
Here’s why: Right now, central banks have the power to respond to what’s going on in the economy. If things are sluggish, they can lower borrowing rates. They can even just print more money. If things are overheating, they can raise rates. They can also make rules about how much cash private banks need to hold in reserve. But all this falls to pieces if people are no longer using the traditional currencies that central banks control.
If the role of a central bank is to keep financial stability, we think this would happen not by ignoring what is happening out there but actually implementing new technologies and bending them in your system, trying to be globally competitive [with innovative solutions] and give more options to the citizens. In other words, if you can’t beat ’em, join ’em. And that’s exactly what’s happening right now. Over the past few months, central banks have been racing to develop their ownforms of digital currency.
A central bank digital currency would be a way of, to some extent, controlling the potential negative impact of having Facebook money or Amazon money. Basically central banks are approaching us to do some pilots and tests of how we can build and design CBDCs. We have been working with a dozen central banks on building such CBDC networks, which involve the central banks, domestic banks but also the payment system providers. And if there’s one country that has responded especially decisively, it’s China.
It recently banned homegrown banks and payment giants like Ant Group and Tencent from handling cryptocurrencies. And in the meantime it’s been very busy creating its own version of digital money – one that it can control. Hundreds of thousands of people in China have already taken parts in trials of the digital yuan – spending their government-issued coins in Chinese outlets of Starbucks and McDonalds. And next year, things are set to go a step further.
The Chinese government already has plans to have Chinese citizens abroad use the digital yuan for transactions. One really interesting event we can watch is the Beijing Olympics in 2022 because they have pretty big ambitions for foreign visitors to use these systems, participate in these broader pilots. The digital yuan is programmable – meaning that it can theoretically be given an expiration date. That way, if the economy is flagging, people can be easily coerced into spending. We think this probably plays into the Chinese government’s plan to have consumption-driven growth.
We do see a little bit of pushback. On the forums people have talked about: what does this actually mean? W don’t have a lot of control over how we spend our money. It also means that for the first time ever – the government will be able to track citizens’ transactions – in near real time. The rather confusing term being used to describe this capability?! “Controllable anonymity.” Controllable anonymity, to my understanding, promises a kind of horizontal anonymity, so you can think of the counter-parties that are involved in a transaction can’t necessarily access each other’s personal information.
But there is no promise or guarantee of vertical anonymity, so any kind of user information can be readily available for the government. So we think that obviously has surveillance implications even if that’s not officially in the official guidance documents.” China’s full-steam ahead approach comes at an already tense time for geopolitical ties. trade conflicts, questions over Beijing’s handling of the pandemic .. not to mention reports of widespread suppression of minorities in Xinjiang are all putting a strain on international relationships. Which brings us to another crucial aspect of this story: Power within the financial system.
Right now, economic sanctions are one of the main ways of dealing with political and trade conflicts. – Think American sanctions on North Korea and Iran – or EU sanctions on Russia following the annexation of Crimea Sanctions are enforced by stopping financial institutions from handling transactions linked to certain individuals, assets or regimes. Some commentators have suggested that China’s digital yuan could enable the country to avoid western sanctions by lessening its dependence on using the US dollar. But others say those concerns are overblown..
That’s a headline. It’s an attention grabber. In the very, very long-run, perhaps, but my thinking is that whether China piloting its own digital currency could eventually unseat the role of the USD, for this to be true there are a few conditions that have to be present. First of all the Chinse Renminbi has to actually be a preferred currency of transaction, which currently it is not, at least compared to the USD. It’s a fair point. While there has been a lot of discussion about the Dollar’s waning dominance, it does still reign supreme.
In 2020, nearly 60% of all global foreign exchange reserves were held in US dollars. China’s yuan, in contrast made up just over 2 % (2.25%) So, as China charges ahead, what is the rest of the world up to? A recent survey showed that 80% of the world’s central banks are exploring their own digital currencies. Major Western powers like the United States and the United Kingdom are in the research phase. As for the Eurozone, the European Central Bank recently announced a multi-year project to create a digital euro. Along with China, South Korea and Thailand are already testing out versions of digital money.
Canada, Russia, Venezuela, Brazil and South Africa are all working on development. Fun fact: the only country to have already introduced a CBDC is the Bahamas! Larger central banks are even more cautious. But they are forming working groups, assessing what are the benefits, risks etc for the banks. And in the case of the European Central Bank in particular, there’s nothing like a bit of competition to speed things up. It depends which is the country that uses the digital currency. If this would be the case with China, we have every reason to invest more in having very fast a digital euro because the Chinese yuan would be used on the biggest platforms like Tencent, Alibaba and Mastercard.
So the pace may differ from one country to the next, but when it comes to the question of rolling out central bank digital currencies, it seems to be less of a question of if, but when. Control over monetary policy and geopolitical wrangling are just some reasons why central banks have an interest in developing digital currencies. But from a consumer’s perspective, what’s the point? The point of central bank digital currencies is in some ways to simplify and enhance the payment systems we have today. If you’ve ever tried to send money abroad, you’ll know that it can sometimes take an age to clear transactions.
Proponents of CBDCs say that a new internationally compatible system would vastly speed things up. This is an especially big deal for the millions of families who rely on money sent home from relatives working abroad. Another group that could benefit are the 1.7 billion people in the world who currently don’t have a bank account: Private, commercial banks don’t have much incentive to give lower income people bank accounts, partially because they don’t want the risk of these people not being able to pay back their debts. If you had a CBDC you could put in place legislation and rules to ensure that everyone would have a bank account so from a financial inclusion perspective, I think it would be a step forward.
Legislation, rules, If you think all this sounds like we’ve come full-circle, you’d be right. After all, the technology that underpins cryptocurrencies like Bitcoin is designed to be decentralized and anonymous. So where does a CBDC fit into that narrative? We basically use the blockchain infrastructure to monitor the supply, to know who owns what and to record transactions. But everything related to identity would be kept in an external system, managed by the banks, the central banks, or the payment service providers.
This is exactly the difference that we have with Bitcoin. It will be like using your credit card, and for a user it will ensure the anonymity but this doesn’t mean that it doesn’t leave a trace of the transactions.” But that’s the very aspect that some people are uncomfortable with fearing that these “traces” could give governments too much power and information about citizens’ spending, similar to the way big tech companies already mine users’ data today
The incentives for a big tech company to issue a monetary token are very high from a gathering data point of view and people might even prefer a central bank digital currency if there was a design mechanism in there that prevented the government getting hold of personalized data on what you were spending your money on.