Central banks around the globe are starting to explore and experiment with digital currencies as they seek to exploit the security and traceability of distributed ledger technology assets and to ensure national monetary systems are not stranded by technological advances.

Some central banks, such as the Reserve Bank of Australia, are merely watching developments, while others are more advanced.

Russia has announced it is planning to launch its own blockchain-based digital currency, dubbed the CryptoRuble, which it plans to use to circumvent international sanctions, although there is scant detail.  Other nations are being more cautious. The Bank of Canada has run a proof of concept test to facilitate interbank payments with distributed ledger technology and in a staff discussion paper late last year outlined the merits of creating its own cryptocurrency, which it said could provide an alternative to credit and debit cards.
The Monetary Authority of Singapore (MAS) is running Project Ubin to evaluate the potential economic benefits of having a tokenised form of the Singapore Dollar on a distributed ledger to Singapore’s financial ecosystem. The MAS is also looking at delivering securities, cross border payments and using a digital version of the Singapore dollar to carry out actual transactions and buy assets.  The People’s Bank of China and the Bank of England are also doing work on digital fiat currencies.

Controlling how money is spent

A central bank digital currency would have many of the same advantages as public digital currencies such as bitcoin – fast and frictionless peer-to-peer transacting, and immutable proof of ownership.  But they would also have specific advantages for governments and national economies, says Robert Allen, PwC Australia Fintech Leader.
“It will enable fast, frictionless, and efficient transactions to take place within the economy and therefore enhance commerce. Faster transaction settlement frees up working capital and for small and medium-sized businesses this will encourage greater competition and investment,” he says.
It would also drive a reduction in the use of cash and hence the black economy.  A key benefit would be allowing governments and central banks to trace money and put conditions on where it is spent. For instance, digital money paid out for welfare payments could have conditions placed on it to ensure it was only spent on food and children’s clothing. Or foreign aid spending could be traced to ensure it ends up in the hands of the people needing assistance rather than being siphoned off and subject to fraud.
“Because of the transparency inherent in blockchain technology and because of its immutability, the fact that it cannot be tampered with, trust that funds are being used for the right purposes will grow, and that’s a good news story for all politicians who are under pressure for misspending or inefficiently spending budgets,” he says.
While digital currencies allow peer-to-peer transaction without the need for a central authority, Allen says he still envisages a role for the commercial banks.  “At the moment, almost all central banks don’t actually control the money in circulation. They allow the commercial banks to do that. That relationship would have to change in a digital currency world,” he says.

Retaining control of the monetary system

“In stable and developed countries, I don’t see that relationship changing any time soon because central banks are and have to be hugely risk-averse and taking on the responsibilities that they have delegated to the commercial banking system will not happen overnight.”
Ultimately, central banks could use the issue of digital currencies to control monetary policy, increasing or decreasing the amount of money on issue according to the state of the economy and tracing how that money is used and circulated.
Allen says much of the technology to support a digital fiat currency is already available, and central banks could start rolling out digital currency pilots within the next five years.
In an article published late last year, Rutgers University Professor of Economics Michael Bordo and Dartmouth College Professor of Economics Andrew Levin warned that central banks need to start considering digital currencies to retain control of the monetary system.
“Given the rapid pace of innovations in payments technology and the proliferation of virtual currencies such as bitcoin and ethereum, it might not be prudent for central banks to be passive in their approach to CBDC [central bank digital currencies],” they write.
“If the central bank does not produce any form of digital currency, there is a risk that it loses monetary control, with greater potential for severe economic downturns. With this in mind, central banks are moving expeditiously when they consider the adoption of CBDC.”
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