In the process, the UAE and Saudi Arabia have rekindled the spotlight on a new trend sweeping the global financial industry and at the same time contributed to the learning quotient on CBDCs. They are part of a growing list of 90 countries committed to various stages of rolling out the CBDC – which is nothing more than virtual money backed by a country’s central bank. These include Sweden, South Korea and Cambodia which have launched pilots and countries such as Brazil, China, the United States and India which have signaled their intention. Together, they create the quotient of experiences to prepare for the launch of a CBDC.
However, the first of the blocs was the Eastern Caribbean Central Bank, which rolled out its pilot in April last year, and then in early December 2021 expanded it to two other islands, Dominica and Montserrat. DCash, the name of their CBDC, has launched in the islands of Antigua and Barbuda, Grenada, Saint Kitts and Nevis, and Saint Lucia. Other central banks are enthusiastic, but have not yet taken the plunge.
So the question is, why is there a sudden surge of interest among central banks around the world for a CBDC? The obvious logic from the outside is the growing popularity of decentralized currencies as a
cryptocurrency. The USP of cryptocurrencies by offering frictionless transactions – especially those involving cross-border transactions like remittances and simultaneously solving trust (the sine qua non of any central bank currency) through the use of a transparent mechanism like the blockchain – offers an alternative currency.
In short, private currencies are poised to compete with fiat currencies. This is something that could potentially shake up the world of finance. Presumably, central banks would prefer to be part of the solution, ensuring frictionless payments at little or no cost to consumers by leveraging the same technology – and thus staying ahead of potential competition. Especially since banning a cryptocurrency in a new world order where currency in the form of code does not recognize geography is hardly an option.
Speaking at a recent webinar hosted by the Vidhi Center for Legal Policy on the CBDC, Deputy Governor of the Reserve Bank of India (RBI), T Rabi Sankar quite frankly admitted this. “It is unclear what specific need these private VCs (virtual currencies) are serving that official money cannot satisfy as effectively, but that in itself may not impede their adoption. If these virtual currencies are recognized, national currencies with limited convertibility are likely to be threatened,” he said.
It is important to keep in mind that the only common aspect between CBDC and cryptocurrency is the underlying technology: the blockchain. In short, blockchain is driving this disruption, and cryptocurrency is just one example of its application. The technology can be used for a multitude of services, including the delivery of social benefits such as pensions, anti-poverty programs and unemployment benefits. Among other things, this will eliminate leaks due to corruption.
The geek definition, sourced from IBM, reads: “It is (the blockchain) a shared, immutable ledger that facilitates the process of recording transactions and tracking assets in a corporate network. An asset can be tangible (a house, car, money, land) or intangible (intellectual property, patents, copyrights, brand image).
Key terms are shared, ledger, and asset. Essentially, the technology enables the interconnection of a secure computer network to conduct transactions where each entity that is part of it has equal knowledge of every step of the transaction. The exact reason why it is also often called decentralized computing – DeFi or decentralized finance – is none other than a blockchain application in finance.
It’s a utopian world in which everyone knows what’s going on. Information is power, not by retaining it but by sharing it with all stakeholders. So, at some level, it becomes all the more difficult to carry out scams without the cover of anonymity. What this very obviously does is reduce the traditional risks associated with a business transaction and, of course, usher in the cost savings. And unlike a centralized system, there is no point vulnerability in the architecture.
At the same time, it is prone to cyberattacks. Nevertheless, dozens of cryptocurrencies have started to emerge. From less than ten a few years ago, a rough estimate puts them at just under 8,000 today. They apply the advantages, efficiency and accuracy of blockchain to the information sector – the only factor that affects competitiveness. As IBM succinctly explains the benefits: “The faster they are received and the more accurate they are, the better.”
Keeping with the previously mentioned definition of blockchain based on a shared digital network, a cryptocurrency is a digital currency created by a private entity — which issues a token, which then becomes the currency; Facebook, for example, calls its token Diem.
Think back to when private currencies existed, before they were replaced by sovereign currencies. This is exactly why cryptocurrency is considered a threat to central bank currencies around the world. In particular the “stablecoin” – one of the popular crypto-currencies – which imitates an official currency because its value is linked to a reserve asset which can be either the US dollar or gold: it is thus less sensitive to volatility, which is the norm with most tokens in circulation.
Unlike the case of a cryptocurrency, a CBDC is based on a private blockchain network and essentially resembles an Intranet. In effect, it will be like creating a PDF version of a printed magazine: the form is different but will do nothing more than fiat currency which is physical.
A cryptocurrency, on the other hand, uses a public blockchain network, which enables decentralized computing – something that is very similar to the global internet architecture. As David Wessel, Senior Fellow and Director of the Hutchins Center on Fiscal and Monetary Policy, Brookings Institution, pointed out in a recent webinar, a cryptocurrency combines network theory (which promotes efficiency), gain (creates incentives by issuing tokens like bitcoins for all participants in the transaction) and cryptography (which provides security).
It is these foundations that pose a threat to central bank-issued fiat currencies, which is exactly why they are moving quickly to close the efficiency gap central currencies face, especially with cross-border transactions involving exports. and imports. Any transaction funded by a CBDC will settle in real time as it is fiat and will not need to go through the rigors of interbank settlements.
This was also established by the Aber project jointly launched by Saudi Arabia and the United Arab Emirates.
Tipping point in global finance
The subtext for this apparent confrontation between cryptocurrencies and the CBDC is as Eswar Prasad, Senior Fellow, Brookings Institution, explained in his just-released book The Future of Money, a turning point in global finance.
“The era of cash is coming to an end and the era of central bank digital currencies has begun. Money, banking and finance are about to transform. Physical money is becoming a relic. The system of digital payment is becoming the norm worldwide The banking industry will change as other forms of financial intermediation gain prominence A large portion of the world’s population will have access to at least basic financial services, improving lines and economic forecasts,” he wrote.
Interestingly, several countries in the developing world are already pushing the boundaries, including enabling financial inclusion and real-time payments. In fact, several of them are ahead of developed countries like the United States when it comes to FinTech innovation. While Kenya’s M-Pesa enables mobile-based money transfer, India’s Unified Payments Interface (UPI) and the most recent launch of PIX, Brazil’s real-time payments, offer similar and effective solutions. All are also forcing a change in consumer behavior, the death of the leather wallet so to speak.
India’s UPI, for example, is capable of resolving any payment in denomination (including for a rupee) and a large volume of transactions. Currently, UPI usage is growing exponentially and is averaging around 2-3 billion transactions per month, but this transactional efficiency can be scaled up, if needed, to 2 billion per day. In fact, in terms of value, UPI was just shy of recording a record $1 trillion in transactions in 2021.
The proposed digital rupee to be issued by the RBI can instantly leverage the growing UPI platform to reach 200 million users – an elusive goal for any country. This could popularize the use of CBDC and enable the Reserve Bank of India to reach critical mass in record time.
Speaking at the seminar organized by Brookings, Prasad framed this competition between
the CBDC and cryptocurrencies favorably. Something where the two systems can actually complement each other and create a win-win for all.
“What is important in my opinion is really a new era of competition that could ultimately benefit both consumers and businesses, but it will come in the form of digital payments of all kinds. And that will be good no only for consumers and businesses within economies, but also for cross-border payments where there are a lot of frictions affecting, for example, economic migrants sending money home, exporters and importers. these barriers will become much smaller barriers to the flow of funding.
Anil Padmanabhan is a journalist based in New Delhi
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