The Race of Central Banks: Who is Working on the Creation of Digital Currencies

Due to the growing public interest in cryptocurrencies, central banks around the world have begun to seriously think about using them. Virtual money earned special attention from financial regulators after the announcement of Facebook's Libra stablecoin launch. What regulators are experimenting with?

Approaches to implementing digital currencies by central banks

Back in late 2018 the International Monetary Fund urged financial regulators to study the use of digital currency seriously. At the end of June this year, the Bank for International Settlements (BIS) announced that central bank digital currencies (CBDC) could become an alternative payment instrument. They also could stimulate increased competition among private intermediaries, which will positively affect the development of innovations in the field of finance, payments and trade.

Currently, financial regulators in about 40 countries are studying the issue of introducing digital currencies into traditional financial systems. As a rule, the central bank plans to increase the efficiency of payment systems through cryptocurrencies.

Experts identify two options for issuing digital money by financial regulators. The first, balanced, or account-based, is when all digital currency users open a personalized account with the central bank. As a result, the regulator begins to perform the functions of an ordinary bank, which entails additional costs for maintaining accounts (including ensuring their security) and significantly reduces the role of financial intermediaries. The second option for issuing digital currencies is the release of fiat money in digital form (value or token-based). Within the framework of this concept, virtual money can become a complete or partial alternative to cash.

In terms of use of CBDC, there are also two approaches. The first one is wholesale. In this case, a limited number of users have access to digital currency. For example, the use of cryptocurrency is carried out only for interbank settlements by financial companies. A few months ago, the central bank of France announced that it had begun to study the practical application of the central bank's digital currency for interbank settlements.

The second is retail (general). In this case, digital currency is available to a wide range of users, including individuals and legal entities. The cryptocurrency, issued by Central Bank, can complement and/or replace cash and be used as an alternative to traditional bank deposits.

Particular attention should be paid to the motivation of central banks to issue a national digital currency. In some countries, regulators are trying to improve the traditional financial system with the help of state cryptocurrencies, thereby reducing the cost of emission and circulation of cash. Such goals, for example, are pursued by the regulators of China, Sweden, Canada.

In smaller countries, the introduction of a national digital currency is seen as an opportunity to solve economic problems (to make the national currency independent of the exchange rate of world currencies) or bypass sanctions (Venezuela, Uruguay).

International experience

Ecuador became one of the first countries whose central Bank issued digital currency (back in 2015), but the project failed, since then society was not yet ready to use digital money.

To date, digital cryptocurrency projects have been implemented by the central banks of Senegal, Tunisia, Uruguay, the Marshall Islands, and Venezuela. For example, in Venezuela, the digital currency Petro was released in 2018, backed by oil.

Many countries are testing projects for the launch of their own digital currency. The central bank of Sweden has studied the potential of using the state digital currency in the local market and identified several basic models.

• The first model is the centralized issuance of CBDC without any intermediaries. In this case, the responsibility for the entire distribution chain of the state cryptocurrency falls on the central bank. The downside is that the central bank is becoming a competitor to private payment services at the retail level, which can lead to a monopoly.
• The second model is the centralized issuance of digital currency with the involvement of intermediaries. In this case, the central bank retains its role at the wholesale level of the payment market, but the operational role in the distribution chain is given to intermediaries.
• The third model involves the creation of a special decentralized database of all digital SEK in circulation, and the function of checking all transactions is assigned to the regulator.
• The fourth model is a synthetic digital SEK. This model is similar to the existing one, where the Central Bank acts as an intermediary for the payment system, and private companies interact with customers directly. A report from the Swedish Central Bank says that this model may prove viable, but it will not be a state cryptocurrency.

In China, the digital yuan project is in the testing phase. The Chinese authorities are considering the introduction of a national digital currency over the past five years. Such technology giants as the payment system Alipay, Alibaba, Huawei, China Merchants Bank, as well as the investment holding Tencent, are connected to the project.

The development of the blockchain architecture for the digital yuan has been completed, and the government is currently developing the legislation. Along with this, China plans to create an infrastructure for the digital yuan and other cryptocurrencies to coexist comfortably.

How to deal with risks

Some countries do not rule out the creation of a central bank digital currency but do not see ways to eliminate the corresponding risks yet. Thus, FRS experts believe that the introduction of a digital currency could cause a fundamental shift in the architecture of the financial system.

For example, after the launch of digital currency, consumers can withdraw money from classic deposits to invest it in virtual money. Not only banks will suffer from this, but also companies that seek investments from these banks.

Along with this, there is a risk of financial instability due to the unwillingness of the traditional financial system to interact with digital currencies. The issue of using virtual money in intercountry interaction has been especially poorly worked out.

However, despite all the difficulties, national digital currencies will be created, because this is required by the conditions of development in the modern world. And even conservative regulators will eventually begin to create their own virtual money based on the experience of other countries.

Image courtesy of Cryptotendencias