The role of sovereign digital currencies in the future of money

The role of sovereign digital currencies in the future of money

Cryptocurrencies such as bitcoin have been making the headlines for their sharp price movements, but they are not the only digital currencies to take note of. Money Mind looks at the role of sovereign digital currencies in the future of money.

Sheets of Lincoln five dollar bill are fanned out at the Bureau of Engraving and Printing in Washin
File photo. (Photo: Reuters)

SINGAPORE: Cryptocurrencies such as bitcoin have been making the headlines for their sharp price movements, but they are not the only digital currencies to take note of.

Many central banks have already started some work on developing their own sovereign digital currencies.

Central bank digital currencies (CBDC) is a digital version of traditional bank notes.

Such digital currencies, which are are governed by central banks, are liquid in nature, and unlike cryptocurrency, relatively stable.

So, instead of issuing and printing traditional fiat money, the central bank issues a digital fiat currency.

This means that a digital dollar has the same value as a paper dollar, or a dollar in your bank account.

In future, it may be that individuals will not have to hold physical bank notes either in their bank accounts, or at home. Instead, they may hold digital money in their mobile phone.

The latest survey of more than 60 central banks by the Bank for International Settlements showed that 86 per cent are exploring the benefits and drawbacks of CBDCs.

In mainland China, a pilot programme in four cities including Shenzhen and Chengdu drew 4 million transactions worth US$300 million.

The pilot was extended to e-commerce platform, JD.com in December 2020.

China calls its digital currency the Digital Currency Electronic Payment system, or DCEP.

Sweden is exploring the idea of going completely cashless, with all transactions to be settled with an electronic equivalent of the krona, the e-krona. Already, cash accounts for less than 1 per cent of transactions in the Scandinavian country.

Other central bankers are more cautious.

The chairs of the US Federal Reserve and the European Central Bank say more time is needed.

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But while different countries are at different stages of deployment, market observers say it is only a matter of time before each country will come up with its own sovereign digital currency.

One concern is that people must feel secure in holding savings and investments in this digital form.

According to experts, the CBDC is a safer and more stable store of value than bitcoin.

In fact, the CBDC may be even safer than the deposits in a bank, said experts.

“When you have money in an account at a bank, that's a liability of that commercial bank. Most deposits are guaranteed by deposit insurance, and ultimately backed by governments, but not all of them. And so, for some kinds of deposits there's a small amount of credit risk," said Mr Nick Hill, managing director of Moody’s Investors Service.

"Whereas cash is a direct liability of the central bank, not a commercial bank, and the central bank in principle, can't default on its own liabilities and a central bank digital currency is designed to have those same properties as cash.”

READ: Central banks sketch out digital currency as China forges ahead

There are some concerns about the use of such digital currencies, one of which is that hackers could get into the system, and the digital money could be lost or stolen.

This, said market watchers, can be reduced by using blockchain technology.

"If you are using the blockchain technologies where there are checks and balances, then it is the hacking will actually be reduced," said Mr Anson Zeall, chairman of IDAXA, which works with government agencies to create international regulation and policy in relation to crypto asset commerce. 

Aside from security, another concern is that the consumer experience must be seamless and convenient and work with existing systems.

READ: JD.com becomes first online platform to accept China's digital currency

To create reach and acceptance for its digital yuan project, the People's Bank of China in October gave 200 yuan (US$30) each to 50,000 consumers selected in a lottery in digital "red envelopes", echoing the country's traditional way of gifting cash.

In the third and biggest of these trials, the city of Chengdu announced earlier this month that it will distribute 50 million yuan in digital currency in a public lottery. Winners will receive digital currency – though reportedly, still in physical red envelopes.

Privacy concerns could however hinder the widespread adoption of the CBDC.

In the digital space, money moves around faster, making it tougher to trace suspicious transaction and activities such as money laundering and terrorism financing.

China has taken the approach of monitoring all transactions closely in real time.

Mr Kelvin Wong, market analyst at CMC Markets, explains how it works.

"Every time we make payment or receive payment using digital yuan, it will be recorded in real time in the ledger of the People’s Bank of China. So, advocates will say, it will be good to track potential money laundering. It can be used to track potential terrorism funding. On the other hand, it may allow the government to know what individual citizens are doing.”

The Swedish approach, meanwhile, allows some degree of privacy.

The Swedish system is based on blockchain technology, which is decentralised and so cannot be easily tracked by the government in real time.

But that does not mean illicit activities can go on unnoticed. Ultimately, there is a digital trail for every single CBDC transaction.

"It's very difficult to ensure true anonymity of a central bank digital currency," said Mr Hill.

"It's really about how difficult do you make it for other people, be they other third parties or be they the central banks or be they governments. How difficult you make it for them to access that data and to monitor flows of cash, digital cash, in a way which they cannot today in the physical cash economy," he said.

Source: CNA/aj

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