Central bank’s digital currency is the next major financial disruption

Wall Street is heating up the idea that the next major disruptive force on the horizon is the central bank’s digital currencies, although the Federal Reserve case is likely to be a few years away from developing.

Led by countries as large as China and as small as the Bahamas, digital money is attracting stronger importance than the future of an increasingly cashless society.

A digital dollar will look somewhat like cryptocurrencies like bitcoin or Ethereum in some limited ways, but differs in important ways.

Instead of a tradable asset with very volatile prices and limited use, the central bank’s digital currency will function more like dollars and have widespread acceptance. It would also be fully regulated and under a central authority.

Many questions remain before an institution as large as the Fed will penetrate. But the momentum is growing around the world.

“A major move to introduce central bank digital currencies (CBDCs) could actually disrupt the financial system,” Morgan Stanley chief economist Chetan Ahya said in a customer report. “Efforts to introduce CBDCs are gaining momentum, with as many as 86% of the world’s central banks investigating digital currencies.”

Indeed, a 2020 survey by the Bank for International Settlements indicated that almost every central bank in the world has done at least some work on these digital currencies. About 60% work on ‘proof of concept’ testing, although only 14% have launched or are in the process of launching a pilot program.

Along with the enthusiasm about a possible new horizon on the financial system, there are concerns about correcting the implementation.

Central bank’s digital currency, on the other hand, advocates several benefits. The most important of these reasons is to give people without a bank access to the financial system.

There is also a speed consideration. Transfer payments, such as the governments to people during the Covid-19 crisis, would be made faster and easier if the money could be deposited directly into digital wallets.

“New forms of digital money can provide a parallel boost to the vital lifelines that overpay to poor and developing economies.” . “The biggest beneficiaries are vulnerable people who send small money transfers: those who are most at risk of being left behind by the pandemic.”

Potential losers from the digital currencies include certain financial institutions, both in traditional banking and fintech, which may lose deposits due to people placing their money in central bank accounts.

There are also concerns about privacy and concerns about integration.

As the Fed and other central banks work through these logistical issues, Wall Street is growing in anticipation of what the future holds.

“The race for Digital Money 2.0 is underway,” Citigroup said in a report. “Some have set it up as a new space race or digital currency Cold War. In our opinion, it does not have to be a zero-sum game. There is a lot of room for the overall digital pie to grow.”

However, there was at least the semblance of a race, and China is considered the early lead.

With the launch of a digital yuan last year, some fear that the rand that China may eventually have could undermine the dollar’s status as the world’s reserve currency. Although China has said this is not its goal, a Bank of America report notes that the issuance of digital dollars will “keep the US currency very competitive … compared to other currencies.”

“CBDCs offer the benefits of improving monetary transactions, without the detrimental side effects of cryptocurrencies,” wrote Bank of America economist Anna Zhou.

Several other countries continued with projects after the Bahamas first launched its Sand Dollar.

The Fed is currently working on a joint project with the Massachusetts Institute of Technology to evaluate the effectiveness of a digital dollar, although there is no specific timetable for when and whether the US Federal Reserve will move forward.

“There are a lot of subtle and difficult policy choices and design choices you have to make,” Fed Chairman Jerome Powell said in a recent 60-minute interview with CBS.

“We do all the work,” he said. “We did not decide to do it because it is once again the question of whether it will benefit the people we serve? And we must answer the question well.”

In a paper on the subject, Greg Baer, ​​CEO of the Bank Policy Institute, a lobbying group in the industry, warns of a possible ‘reduction’ of the traditional banking system. He added that “the impact on economic growth could be significant unless the central bank also accepts responsibility for lending or becomes a regular source of funding for banks.”

“The way forward is currently uncertain, and design choices can lead to many different results,” Baer wrote. He notes the Fed’s warning and how it contrasts with the European Central Bank’s “more precipitation” action.

The ECB is continuing its “britcoin” project, although it has said it will simply be a channel for banks, acting as an intermediary for digital currency accounts.

“This ‘britcoin’ would be linked to the value of the pound to eliminate it as an asset to make a profit. There could be an economic impact in the form of greater investment in the UK technology sector and lower transaction costs for international companies., “says Jeremy Thomson-Cook, chief economist at international business payments specialist Equals Money.

“I think it legitimizes the belief that cash is going the way of the dodo and that the broader payment landscape will be completely online within the next decade, apart from casual or quixotic spending,” Thomson-Cook said.

Even with the seemingly unwavering move towards digital currencies backed by central banks, the US authorities seem determined to take their time.

Powell also said the Fed would not act without specific congressional authority and said there are several concerns that need to be addressed.

“While the central banks’ CBDC initiatives are not intended to disrupt the banking system, they are likely to have unintended disruptive consequences,” Morgan Stanley’s Ahya said. “The wider digital currencies are accepted, the more opportunity for innovation and the greater the room for disruption of the financial system.”