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The Rise of Digital Currency

Globally, and profoundly, nothing has had such a dramatic impact on our concept of money as the arrival of Bitcoin in 2008, devised by the mysterious Satoshi Nakamoto, someone – to this day – who still remains unidentified. Since that time, the debate surrounding the viability of cryptocurrencies as legitimate tender has been fierce, even though the underlying technology could be used for all manner of society-critical systems in the future. The central banks of a host of countries have begun the development of their pseudo-cryptocurrencies, known as Central Bank Digital Currencies (CBDCs), and this article explores how they are evolving…


First Steps


In the last decade or so, there has been greater pressure to try to resolve the issues brought about by the continued use of traditional or fiat currency. Although the issues are complex, the last financial depression – thought to be a particularly bad one – seemed to create new urgency to come up with a means to remove the traditionally necessary corporate middleman from any financial transaction.


Perhaps a threshold moment came when blockchain arrived on the scene in the form of Bitcoin: a cryptocurrency. Since that time, the race appears to have been on to come up with a fully digital form of currency that provides the freedom craved by the huge number of cryptocurrency adherents, but also can be regulated so that critical social functions can also be accommodated.




Figure 1: Entities that are in the process of developing digital currencies, or have implemented them (as of April 2021 (Deloitte))

The growing pressure for a viable and truly digital currency has pushed the national banks of a number of nations to try to develop their own. These have come to be known as Central Bank Digital Currencies (CBDCs), and according to Investopedia, are ‘pegged’ to the value of a country’s fiat currency.


Figure one shows the raft of entities globally that are researching the possibility of a CBDC, are in open testing of one or have actually gone live. As noted in Investopedia too, the following countries have already launched a CBDC; The Bahamas, Antigua and Bermuda, St Kitts and Nevis, Montserrat, Dominica, Saint Lucia, St Vincent, and the Grenadines, Grenada, and Nigeria. Perhaps it is of special note in figure one that entities such as the Bank of England, the People’s Bank of China, and the Digital Dollar Foundation are all involved, organizations that have a significant influence on the global economic stage.


Not Crypto


Effectively, CBDCs are not cryptocurrencies, even though as a concept they have been derived from them. Cryptocurrencies arguably gained their following from the freedom that they purported to provide: decentralization, or, a way in which to unchain the management of money from financial institutions and governments.


As attractive as this might sound to many, for the happy functioning of at least some critical systems of society (and discussed by this author elsewhere), money does still need to be managed centrally (taxing for example, which is necessary for the continued provision of emergency services – and other things - to the wider public).


The brightest brains have failed to reconcile these issues with the complete decentralization of cash and perhaps CBDCs have emerged as a consequence. It is worth noting too, that not all CBDCs need to be based around blockchain technology. The more noble idea is to take aspects of cryptocurrencies that are beneficial – such as their difficulty to counterfeit and exposure to external tampering – but still include those aspects of fiat currency that society requires.


Challenges


A CBDC could bestow a number of advantages on a country that embraces it. The risks of runs on banks and financial institution failures will be greatly reduced. Moreover, cross-border payment costs will be lower with the diminished complexity of transfer systems and easier cooperation between international bodies and governments.


Even more, economic infrastructure could be brought to populations of the unbanked – people who do not have access to a financial institution but do have a digital device like a mobile phone. Also, where consumers will have direct contact with central banks, otherwise costly infrastructure will no longer be necessary.


CBDCs however, are not without their challenges. The broad-scale changes a digital currency would bring to household expenses, investments, banking reserves, rates of interest, and the wider financial and economic sectors remain unknown. With the unknown comes immeasurable risk. More specifically, the effect of a CBDC on liquidity is unknown, for example, during a financial crisis and the facilitation of money withdrawals. Equally, central institutions use monetary policy to impact inflation, as well as interest rates, spending, and loans, which influence things such as employment rates. Implementing CBDCs will require that central banks have the tools at their disposal to positively nudge the economy.


Also, cryptocurrencies have seen their fair share of press coverage, not least of all because of the attention they have attracted from thieves and hackers. CBDCs will no doubt attract the same groups and will therefore require substantial protections and securities to make them worthwhile.


As touched upon previously, the decentralized nature of cryptocurrency enables the supreme privacy of the individual. This facet of cryptocurrencies alone fostered an immense following and has remained a hot topic of debate.


For CBDCs to function, a marked level of intrusion would have to be included. Not just because of the need for governments to collect taxes (again as previously mentioned), but also because of the need to monitor and regulate financial crime, primarily in the forms of money laundering and the financing of terrorism. These two economic elements are so huge as to be threats to the national security of whole countries and could fill the space of an article by themselves.


Leviathan


105 countries, which represent around 95% of global GDP, are exploring a CBDC as of May 2022 and according to the Atlantic Council. This is in comparison to two years previously when only 35 countries were exploring the use of digital currencies. Thus far, 10 countries have fully launched a digital currency, with the leviathan in global finance – China – set to expand through 2023.


Many more countries too, are exploring the possibility of CBDCs due to the advent of Russia’s invasion of Ukraine. Of the G7 economies, the UK and the US are the furthest behind in their development of a CBDC, with the European Central Bank looking to deliver a fully digital euro by the middle of the 2020s. Significant progress has also been made by Russia, India, Japan, and South Korea in the last six months (16 of the G20 countries are already in the development phase of their digital currencies).


All this activity has caused some experts some consternation since the world financial system may suffer at the hands of profound interface and inter-connectedness issues through a lack of accommodating infrastructure and international standards. Everything is happening apace and other aspects of society must dash to keep up. It is a space being watched and influenced by many.

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