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EuropeFX: What about digital currencies?

finanzen.net
11/12/2020

What is it with digital currencies?

Central banks are reportedly toying with the idea of switching to digital currencies. This is in stark contrast to the whole idea of cryptocurrencies trying to overthrow traditional forms of money.

How will the money be managed in the future? This is the hot topic of the debate, compounded by Facebook's Libra project. Major economies around the world have embarked on a quest to find out if the Central Bank Digital Currencies (CBDC) could replace the current, established authority over money.

So let's take a look at some of the most frequently asked questions when it comes to the rise of digital currencies and their integration process.

Are cryptocurrencies the same as CBDCs (Central Bank Digital Currencies)?

The simple answer is no, and here is the explanation:

Central bank digital currencies are conventional money only in digital form that is distributed, regulated and controlled by a nation's central bank. Cryptocurrencies, on the other hand, are generated by mathematical equations and puzzles and, unlike a centralized financial institution, are regulated by separate online bodies and communities. Examples of cryptocurrencies are Bitcoin, Litecoin, Namecoin and Peercoin.

However, both CBDCs and digital cryptocurrencies have something in common; they are both based on blockchain technology. It is this technology that enables transactions to be recorded and processed.

The value of cryptocurrencies depends on the financial markets

Some retailers take and accept Bitcoin as a form of payment, but cryptocurrencies are not classified or legal tender; this enables the CBDCs to distinguish themselves as the new modern form of money.

The value of cryptocurrencies depends on financial markets, while CBDCs are affected by economic growth, monetary policy , interest and inflation rates, and trade surpluses.

What is electronic money and where does it fit in?

The way we pay for goods and services is evolving. Contactless debit cards and e-money have made the buying process easier for customers and retailers. However, this is also in contrast to the CBDCs.

What is electronic money?

Electronic money is money that is in bank computer systems and can be used to facilitate electronic transactions. Although its value is backed by fiat currency and can therefore be exchanged for a physical, tangible form, the sheer convenience of this method makes electronic money primarily used for electronic transactions.

CBDCs would not only be a substitute for traditional money, as is the case with electronic money, but would completely replace legal tender as it is.

What are the benefits of Central Bank Digital Currencies (CDBCs)?

Various central banks have hinted that the CBDCs could compete with the surge in cryptocurrencies, particularly Facebook Libra, which is slated to launch this summer.

Central banks view the CBDCs as the future of payments; As payment systems are today, they are often time consuming and expensive. Digital currencies could offer a more streamlined payment process that could fuel economic growth.

Although cryptocurrencies like Bitcoin are hampered by the unpredictability of financial markets , they pose no real threat to central banks' monetary policy and legal tender. However, central banks and governments around the world are increasingly concerned that Facebook is the traditional way of making money managed, could disperse. Facebook has more than 2.7 billion monthly active users; this is fueling fear among central banks as they fear that the traditional way of monetary policy could be superseded and adopted by the social media platform.

The CBDCs offer all the advantages of a cryptocurrency, avoid the volatility of the financial markets while retaining state control over monetary policy.

At a time of negative interest rates, central banks believe the CBDCs could stimulate new business investment.

How long until the introduction of CBDCs?

Most of the CBDC projects are still in production, so it's very early. According to the Bank for International Settlements (BIS), a growing number of central banks are planning to introduce their own digital currencies this decade.

On the list of the largest economies, the People's Bank of China is on the verge of becoming the first central bank to adopt CBDCs. The details of the project are limited, but reports suggest that it is based on blockchain technology and could be distributed to retail banks and financial organizations.

Other countries are a little skeptical about the new digital currency that could change the world as we know it. The central banks of the UK, Japan, Switzerland, Sweden and the bloc announced earlier last week that they would work together to compare results while exploring both the pros and cons of adopting the CBDCs as a replacement for the traditional legal one Investigate means of payment.

What do the major central banks think about the CBDCs?

There is a general feeling of insecurity and reluctance among central banks.

The US Federal Reserve has distanced itself from the initiative of other major central banks to assess the advantages and disadvantages of the CBDCs.

On November 19, 2019, Federal Reserve Chairman Jerome Powell wrote a letter to French Hill of the House of Representatives explaining how the Federal Reserve assesses all of the effects of CBDC adoption, including the consequences it will have for the commercial banks, privacy and the possible increase in cyberattack cases.

"In analyzing the potential costs and benefits of the general purpose CBDC, we are carefully monitoring the activities of other central banks to identify potential benefits that may be relevant in the US context," said the Fed chairman. "To date, our observation is that many of the challenges they hope to face do not apply to the US context, such as the non-use of physical cash, tight or highly concentrated banking sectors, or poorly developed payments infrastructure in general."

Japan's central bank warned that any uncertainty about the impact the CBDCs could have on retail banks and other financial institutions needs to be addressed. The Bank of Japan also debunked the suggestion that the central bank's digital currencies could compound the effects of negative interest rate schemes.