Blockchain Is Changing The Game: Why Do Central Banks Need Digital Currency?

In accordance with coinmarketcap.com, at the end of August the total capitalization of the crypto market became more than 217 $ bln. The market has shown the developing dynamic increased by 30% in comparison with the corresponding figures of the last year. Global traditional financial institutions cannot leave the blockchain unnoticed. In the series of materials we will analyze which institutions in the financial industry start to use the blockchain technology and how they implement it in their operation to pursue the trend. Let's begin with the main financial regulator.

Central banks one by one are making announcements about launching their own digital currencies. The last one for today was the Bank of Thailand. This crypto project should technologically prepare the financial sector for successful implementation of new financial tools which will increase the operational efficiency. By creating its own blockchain network the Bank of Thailand will make the first step towards the country's new financial infrastructure.

Digital currency introduction can widen the number of means central banks will be able to use in their monetary policy and probably solve the problem of breaking through the zero lower bound. The issuance of paper currency guarantees a zero nominal interest rate creating an interest rate floor. During economic crisis the central bank may decide to lower the short-term nominal rate in order to stabilize the economy. But if this rate is already close to or equals zero, then its reduction can lead to negative consequences. It becomes unprofitable for people to keep their savings on deposits in case of a zero or negative rate and therefore they will withdraw their funds from bank accounts. As a result, the banking sector falls into a liquidity trap, which limits the central bank's facilities to stimulate an economic growth.

However, we see that developed countries such as Switzerland have been already applying the negative nominal interest rates to their economies. Swiss National Bank is currently maintaining it at the level of - 0.75%. In spite of zero or negative nominal returns, depositors continue to hold their savings on bank accounts due to the convenience and security of their storage. For the banks' turn, they also go on keeping their funds on the central bank's accounts as the reserves conversation into paper money will lead to their inefficient and unsafe management and the inability to make transactions and transfers swiftly. Nevertheless, the negative rate can be applied to deposits only, while it can not affect cash turnover in the current conditions, which confines the capabilities of the central bank.

Back in 2015, Miles KIMBALL, American economist, Jr. Professor of Economics at the University of Colorado Boulder, said that digital currency should be the unit of account in order the central bank to have a negative interest rate in all assets, not solely in deposits - it is not possible when the unit of account is paper currency as paper money has specific numbers printed on it. According to KIMBALL, the negative rate for paper currency can be used in the central bank's cash window where banks come to deposit or withdraw paper currency from the central bank.

Many developed economies face the problem of zero lower bound. Japan is the most illustrative example. The country's interest rate is negative and amounts to - 0.1%. The entire period of the 1990s and 2000s is called the lost score, when Japanese economy has been experiencing stagnation. The government is trying to change the situation and aims to reduce cash flow.

About 70% of all payments are made in cash. As a result, financial institutions are facing a shortage of liquid funds and bearing additional expenses on issuing, transporting, collecting and auditing paper money while the government is experiencing the tax shortfall due to cash payments on the black market. In this regard, a group of Japanese banks, including Mizuho Financial Group and Japan Post Bank plan to launch a national digital currency J-Coin by the start of the Summer Olympic Games 2020 in Tokyo. The initiative was supported by the Bank of Japan and financial regulators. The rate of the Japanese cryptocurrency will be tied to the yen rate in a ratio of 1 to 1.

News about the launch of virtual currencies on the national level is increasingly accompanied by the term "cashless society". In the working paper " Breaking Through the Zero Lower Bound " IMF authors analyze the mechanism of partial elimination of physical banknotes and coins by using a time-varying paper currency deposit fee between private banks and the central bank. This allows the central bank to create a crawling-peg exchange rate between paper currency and electronic money so that the paper currency interest rate can be either lowered below zero or raised above zero. As the paper currency interest rate can be varied the central bank gains a tool to stimulate investment and net exports as much as needed to revive economy in conditions of low inflation, interest rates, and economic activity.

On the whole the government improves a banking infrastructure by launching its own digital currency. Public procurement becomes more transparent while transactions get faster and more reliable, less expensive due to the intermediaries removal. Gaining a greater control over the financial operations of banks and citizens, the central bank wins an opportunity to return cash in hand to the documented money turnover and reduce the volume of the black market where cash payments are made.