Promising future of central bank digital currencies

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Transparency-enhancing blockchain-based CBDCs are a promising way to achieve three goals: freeing up the annuitant payment system, ensuring unprecedented transparency on the amount of money extracted from the currency tree, and democratizing access. to the fruits of the tree.

Digital currency has so far managed to emerge as one of the strongest flavors in today’s financial market. What sets digital currencies apart from all of their predecessors is the tremendous new features they promise to offer. It’s the financial equivalent of switching from postal service to email.

Money essentially fulfills three functions. As a medium of exchange, it allows for transactions that otherwise would require difficult bartering (such as in swapping chickens for a car).

As a unit of account, it allows you to know whether you have saved or not during the past year. And as a store of value, money allows current income to fund future purchases.

According to the IMF, the desirability of central bank digital currencies (CBDC) depends solely on its ability to improve these three essential functions of money.

Interestingly, the idea of ​​CBDC is gaining support from financial institutions such as the Bank for International Settlements, known as the central bank of central banks. These financial custodians are embracing the CBDC because they can see that if they don’t, someone else will.

A recent survey by the Bank for International Settlements indicates that 86% of central banks are actively pursuing digital currencies. And almost

60 percent of banks are in the testing phase.

By some estimates, a fifth of the world’s population will be exposed to a central bank digital currency within three years. By 2027, some $ 24 trillion in global assets are expected to be in digital form.

The dollar and the changing financial landscape

Although the US dollar remains the dominant reserve currency in the world, the downward trend in global US dollar reserves to an all-time high of 59 percent in 25 years has succeeded in crushing many of them.

Some cite a combination of countries moving away from the US dollar and the growing status of competing currencies like the euro, Japanese yen, and Chinese yuan as factors in the US dollar’s fall. But others are of the opinion that the hegemony of the US dollar does not appear to be threatened in the near future.

Russia and China have both moved away from an uncertain and politically entangled US dollar in recent years, with the Central Bank of Russia (CBR) giving up more than $ 101 billion in dollar-denominated reserves in early 2019. China, for his part, loosened his grip. on US government securities, with a 20 percent decrease in such holdings over about seven years, according to data from the US Treasury Department.

Blockchain-based digital currency looks promising

Despite the controversy over the pros and cons of CBDCs, governments around the world are increasingly exploring, researching or testing the implementation of programmable digital fiat. The eight central banks of major currencies in the IMF report are actively considering, researching or developing a CBDC.

Transparency-enhancing blockchain-based CBDCs are a promising way to achieve three goals: freeing up the annuitant payment system, ensuring unprecedented transparency on the amount of money extracted from the currency tree, and democratizing access. to the fruits of the tree.

At the retail level, a CBDC would offer clear advantages. This would help the poor and others who are currently underserved by the banking system. It would also make it much easier for governments to administer social transfers such as household cash disbursements made during the pandemic. And a well-functioning international digital currency system would significantly reduce cross-border transaction costs.

However, in addition to various privacy concerns, CBDCs have their own complications. A crucial question is where the CBDC accounts would be held. If it is at the central bank, how will the confidentiality of transactions be preserved? It is also unclear what role would be left to private banks, which are currently the main source of credit in most market economies. If the banks no longer receive deposits, how are they going to issue loans?

For such an arrangement to work well, the CBDC would have to strike a difficult balance between anonymity (privacy) and control of the system. Otherwise, any concerns about the government’s unrestricted access to account holder information will start to sound legitimate.

The viable alternative for the central bank is to allocate deposits to member banks, which would then continue to function as sources of credit. In this case, strong fractional reserve requirements would be required.

Regarding privacy concerns, it is possible to anonymize central bank accounts with digital labels that only an independent regulator can trace to natural persons. After all, let’s not forget, our current payment system (with strict “KYC” rules) does well with illusory confidentiality.

There are also complications at the international level. Would central banks be prepared to accept payments in CBDCs from other central banks? Could countries keep control of their money supply once it has taken on a digital form?

At present, it is very difficult to imagine a future scenario where the big central banks would be ready to subscribe to the international financial system without a high degree of cooperation, coordination and control.

The way to go

These international issues are of particular importance to the United States as the dollar has served as an international reserve currency, unit of account and means of payment for 75 years. For better or worse, the dollar’s key role in the system has allowed the United States to impose reasonably effective financial sanctions on countries like Russia and Iran, and the United States is not d mood to voluntarily give up this tool.

No monetary system has ever worked perfectly. But it is generally believed that the current system has worked well over the past few years, especially compared to earlier systems such as the Gold Standard.

While a CBDC can improve financial inclusion, most experts warn that it should not be inaugurated until there is assurance that credit allocation, payment systems, financial stability guarantees and other aspects of the new system would work at least as well as they do under the current one. There is no doubt that the central bank’s digital currency will arrive sooner rather than later. The question, then, is whether all issues (both identified and emerging) will be resolved before the transition takes place.

(The writer is an economist, former IRS officer and author of the upcoming book “The Current Perspective on Indian Economy”)

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