The future of central bank digital currencies

The 21th century is showing a very different landscape due the rapid development of technologies and the digitalisation that is transforming paper money into virtual currencies.
For a peek into the future of money, take a look at what is happening in China.

Earlier this month the Chinese government reiterated its hostility to bitcoin mining while the Central Bank of China ramped up plans to roll out the digital yuan.

The idea behind the digital yuan is to replace cash (which fewer people want to handle post-Covid), clamp down on cash-related crimes, and improve the convenience and costs of transacting.

It’s also been suggested that the digital yuan would give China the upper hand in its trade war with the US, and remove the risk of its SWIFT international bank transactions being wiretapped by the US, as whistleblower Edward Snowden claimed.

Too much (personal) info

Free societies should be wary of China’s motives in introducing a digital yuan.

China may be the most surveilled society in history, using millions of facial recognition cameras to track citizens. It then integrates this with big data analysis and artificial intelligence to come up with a “social score” for every Chinese citizen.

It introduced the social credit scoring system in 2014, issuing demerit points for bad behaviour such as playing loud music, eating on rapid transit systems, violating traffic rules and jaywalking. You can win points back by donating blood, completing volunteer hours or saying nice things about the government on social media.

Add a digital yuan into this stew and the surveillance capabilities are truly terrifying. The Central Bank of China will be able to track citizens’ purchases in real time.

“The digital yuan is both programmable and trackable, giving the Chinese government enormous control over the economy. Not only will Chinese policymakers know every consumer choice made in the economy, but they could also directly affect spending behaviour by making the currency expirable by a certain date,” said Boris Schlossberg, MD of forex at BK Asset Management, according to Bitcoin.com.

Schlossberg adds that this policy objective will backfire, driving more people into cryptos that are outside the reach of authorities.

Though more than 50 central banks around the world are at various stages in researching or planning the introduction of digital currencies, China is way out in front – notwithstanding its hostility to bitcoin.

Bitcoin is the antithesis of central bank digital currencies (CBDCs) – it is decentralised, secure, anti-inflationary and proven itself over 11 years to be a decent, if volatile, store of value.

Moves in SA

The South African Reserve Bank (Sarb) recently announced that it is commencing a feasibility study for a general-purpose retail CBDC.

“The Sarb has embarked on a study to investigate the feasibility, desirability and appropriateness of a CBDC as electronic legal tender, for general-purpose retail use, complementary to cash,” says the Reserve Bank in a statement.

“A retail CBDC can be defined as a digital form of cash aimed at providing the best attributes of both cash and electronic payments.

“The objective of the feasibility study is to consider how the issuance of a general-purpose CBDC will feed into the Sarb’s policy position and mandate.”

The study will focus on the issuance of a domestic CBDC that can be used by consumers in SA for general retail purposes.

‘Essential’ for financial inclusion

Sonny Fisher, founder of blockchain company Forus Holdings, argues that CBDCs are essential to achieving digital financial inclusion.

One objective is to replace paper money with digital cash, which should make a significant leap into the promised age of financial inclusion, while reducing the costs of paper issuance, as well as the risks and social impacts.

“We are, however, mindful of the fact that the introduction of digital money poses the potential for the state to intrude on our private lives,” says Fisher.

“This is why the rules around privacy, confidentiality and anti-money laundering measures need input from the entire ecosystem. A failure to address these realities will pose a significant risk to the adoption of digital money.”

Economic impacts

What about the impact of digital money on money supply and inflation?

The tiny Marshall Islands in the Pacific Ocean last year announced the launch of the Marshallese Sovereign (SOV), a digital currency operating on the Algorand blockchain in parallel with the islands’ main currency, the US dollar. The SOV money supply growth is fixed algorithmically at 4% a year to prevent inflation. This percentage growth in money supply cannot be altered by the whims of politicians or budgetary emergencies.

Fisher says the perception that CBDCs or digital money will be able to impact money supply is a misnomer. “Retail currency, both cash and deposits, make up a tiny portion of the money supply. In fact the introduction of a single digital store of value that is interchangeable, will reduce the amount of capital banks, retailers, fintech providers and money transfer agents need to tie up in expensive liquidity pools.

“The introduction of digital currency is guaranteed to increase per capita GDP and stimulate growth among SMEs.”

Sarb study

The Sarb feasibility study will include practical experimentation across different emerging technology platforms, taking into account a variety of factors, including policy, regulatory, security and risk management implications.

“It should be noted that while the CBDC feasibility study is different from [another Sarb-led project called] Project Khokha, which focuses on the settlement of high-value transactions between commercial banks and other stakeholders at the wholesale level, it is expected that the two studies will result in better policy alignment and coordination.”

Trade-off

Monica Singer, SA lead for blockchain company Consensys, says technology always poses a trade-off between added convenience and the potential for official abuse. In the case of CBDCs, protections can and must be put in place to protect privacy and security of citizens.

“For example, the Bank of China proposes tracking all digital yuan transactions of any size. A far more preferable approach is to emulate the Digital Dollar project of the US, which says any transaction below $10 000 should remain private, similar to the use of cash and the KYC [Know Your Customer] requirements.

“With the adoption of a CBDC, the cost of issuing banknotes and coins can be reduced, along with the risk of hijacks that take place on the vans transporting cash and the bombing of ATMs.

“The use of blockchain technology can ensure that taxes are collected in real-time and the complete audit trail is available,” says Singer.

“The Reserve Bank will be able to distribute universal basic income and social grants on a real-time basis, should this be the policy of the government of the day.”

Cooperation

Singer says the implementation of a CBDC should be done in cooperation with the private sector. “It is in the national interest and it requires the public good to be the paramount criteria over the profits that are generated by third party intermediaries. As new payment rails are being created, the citizens should be free to choose what type of money they will want to use. I hope that there will not be wall gardens between the different currencies and a free flow is allowed in the future across borders.

“Programmable money will ensure that these funds that are distributed real time directly into the wallets of citizens that qualify or students will ensure that those funds are programmed to be used only for the purpose that they are intended to be used. This is possible because of smart contract functionality in the internet of value, which is Ethereum.”

The ideal role for a central bank is as overseer of the CBDC platform and its governance.

“The banks and other institutions can be the ones interacting with the public to open up e-wallets,” adds Singer.

“I would also like to see that CBDCs are interoperable with other CBDCs so that they are transferable across borders peer-to-peer, no matter where people live. CBDCs should also be interchangeable with other forms of money like cryptocurrencies, stablecoins and the many private coins that will be issued in the future by financial institutions and other private entities like Facebook [with its stablecoin Diem], or fintechs.” – Moneyweb