The developments in blockchain and the ever-growing number of users of cryptocurrencies such as Bitcoin, Bitcoin Cash, Litecoin, Ethereum, Tether, and others, is a reality that cannot go unnoticed. Countries and banks can see this trend and are starting to take steps in the same direction.
Central banks in over 45 countries (as of May 2020) are exploring ways to create a CBDC (Central Bank Digital Currency), often with the use of a limited form of DLT (Distributed Ledger Technology). Among the reasons to do so is the issue with the current fiat money.
All the money we use today is fiat money, with the term fiat coming from the Latin “let it be done”. Simply put, no national currency is backed by anything tangible or physical, such as gold or silver anymore, and that’s why it can be freely printed. After printing or issuing new money, the government in effect says, “let it be money.” It is valuable only as long as it is supported by the government which stands behind it. That’s why it is susceptible to inflation, and it can be a devastating inflation, as can be observed in some countries. In such cases, fiat loses the basic function of money – holding value.
This is probably the principal reason why digital currencies and cryptocurrencies are becoming so interesting to people all over the world. And when Facebook came up with its project of Libra as global currency and financial infrastructure, the central banks and large financial institutions took it as a wake-up call finally to start addressing the flaws in its current payment system.
Digital Currency vs Cryptocurrency
Some people use these terms interchangeably, but digital currency and cryptocurrency is not the same thing.
Digital currency: Digital currency, digital cash, digital fiat currency, CBDC (Central Bank Digital Currency) is an electronic version of notes and coins. Digital currencies are regulated and centralized through a central location, typically a bank that oversees and regulates the transactions carried out within the network. By their design, digital currencies are not transparent. Digital currencies also aim to deal with difficulties in tracking and fraud and with the high costs of cash handling and issuance.
Cryptocurrency: On the other hand, cryptocurrencies are decentralized. In the case of any regulations, these are governed and decided on by the whole community, for example, by voting mechanisms on the blockchain. Thanks to the distributed public ledger, cryptocurrencies are transparent and immutable. Bitcoin is pseudo-anonymous, some cryptocurrencies are absolutely anonymous and private.
Digital Currency and the Banking System
With a view to digital money or digital currency, the banking system seems to address these key functions of money:
- Issuer: Central bank or not.
- Form: Digital or physical.
- Technology: Account-based or token-based.
- Accessibility: Widely accessible or restricted.
Starting from these points, the BIS (Bank for International Settlements) sets out some fundamental characteristics of a CBDC (Central Bank Digital Currency): CBDC is issued by a central bank, and it’s not physical but digital. At the same time, it’s also possible to have general purpose central bank accounts which are account-based (these aren’t tokenized). In case the digital money is converted to digital tokens (i.e. it is tokenized), there are two possible types: “general purpose” digital money (CDBCs) which the BIS denotes as “digital cash”, and “wholesale” CDBCs meant for financial institutions only.
The main characteristics of CBDC (Central Bank Digital Currency) should follow the functions of money (bank notes and coins), as we know it. Thus, CBDC is supposed to be a means of payment, an accounting unit, and a store of value (in a relative way, since it remains fiat currency).
Venezuela and Digital Currency
As has been noted, fiat money is susceptible to inflation, even hyperinflation. Venezuela is such an example. After the people in Venezuela have suffered from inflation and hyperinflation in recent years, the government took steps to overcome US sanctions. In 2018, Venezuela started with their own digital currency petro or petromoneda with the intent to create a “strong currency backed by raw materials”, such as oil, gas, gold and diamonds.
The fact is that this digital currency has been banned by the United States, and as of July 2020, it remains to be seen if it will be accepted more widely. But in the meantime, cryptocurrencies gained an immense popularity in Venezuela since these can be used very reliably in case of inflation and hyperinflation.
Canada and Digital Currency
Inflation and hyperinflation is not the only reason to issue a digital currency as a preventive measure. For example, the Bank of Canada is exploring ways to create its own digital currency to protect the Canadian dollar and monetary sovereignty.
On Feb 25, 2020, Bank of Canada Deputy Governor Tim Lane stated at CFA Montréal FinTech RDV 2020 that the CBDC (Central Bank Digital Currency) prototype is on the way:
“The Bank of Canada would design it to provide the benefits of cash – safe, easy to access, private, and a good store of value – but in a digital version that consumers could use to buy things electronically online or in person at a shop.”
Lane observed that private cryptocurrencies are seen as potential threats to the Canadian dollar and added:
“If one or more alternative digital currencies threatened to become used widely as an alternative to the Canadian dollar, then a central bank issued digital currency could be used to defend monetary sovereignty.”
At the same time, the Canadians were reassured that their cash would not be supplanted by digital currency anytime soon: “The Bank of Canada will make sure bank notes are available to Canadians who want to use them.”
China and Digital Currency
China has been exploring possibilities for their digital currency since 2014. The pilot version was launched in spring 2020, when China started testing their digital currency in their four large cities – Chengdu, Shenzhen, Suzhou, and Xiong’an.
A part of testing is a dedicated e-wallet app with several functions to send payments, request money, make retail payments, and execute P2P payments. Users should be able to see all their transactions in their e-wallet, link it to other accounts and manage their finances.
After thorough testing, the official DCEP (Digital Currency Electronic Payments) system might be launched within a year. China’s digital Yuan is set to be centrally controlled. The central bank should be issuing the digital currency to banks or institutions, which will be circulating the digital Yuan among their customers. Mu Changchun, Deputy Director of the PBOC (the People’s Bank of China) said that the digital currency is expected to consolidate China’s monetary sovereignty.
Although digital Yuan appears to be designed for domestic use, it is hoped to make cross-border transactions easier, too. China has not been happy with the USD’s position as the global reserve currency, and would definitely want to conduct its international trade in Renminbi (RMB). And this is where their new digital currency could start playing an important global role.
Digital Currency: Opinions and Explorations
Most central banks (up to 80%) and financial institutions around the world concern themselves with digital currency and explore new possibilities in this field.
Anonymity and Privacy: Some banking experts advise that the new digital currency should not be anonymous, explaining that with our current banknotes and coins we have too much privacy.
European Central Bank: For the time being, it is the only entity issuing European currency – Euros as banknotes and coins. The debates are revolving around the question whether ECB should also retain an exclusive right to a digital issuance, or whether individual countries within the European Union could issue digital currencies.
FED: There are calls for the U.S. Federal Reserve System to explore the possibilities of CBDC (Central Bank Digital Currency).
IMF: The International Monetary Fund published a paper outlining advantages of the Central Bank Digital Currency. Among the pros is a more efficient payment system without costs to manage cash.
The Netherlands: De Nederlandsche Bank (DNB), the central bank of the Netherlands states in its recent report that private payment platforms could sooner or later replace public cash. DNB wants to uphold a major role in CBDC (Central Bank Digital Currency) within the Eurosystem.
More and more examples are coming every month, from which it is apparent how hot this topic of digital currencies is at this time.
Digital Currency or Crypto Currency?
The shift to a cashless society is quite apparent. Which will it be in the end: Digital currency or crypto currency?
As we have seen, digital currencies are centralized and regulated, they belong to the issuer, and constitute a form of fiat money as we have known it. With digital currencies, you cannot check the whole transaction history. Thus, they are not transparent. They are under a central authority that can cancel or freeze transactions. And they fall under directives and legal frameworks stipulated by central banks and financial institutions.
On the other hand, cryptocurrencies are decentralized, with regulations, if any, governed by the community, typically by voting on the blockchain. They are transparent, since you can go to a public ledger and check all the history of transactions ever made. You can make peer-to-peer payments globally, very fast and with very low fees. Only time will tell what the majority of people will prefer and use in their everyday lives.