The central bank’s digital currency is the next major financial disruptor

Wall Street is warming to the idea that the next big disruptive force on the horizon is the central bank’s digital currency, even though the Federal Reserve is likely to remain a few years away from developing its own.

Led by countries as big as China and small ones like the Bahamas, digital money is attracting stronger interest than the future of an increasingly cashless society.

A digital dollar resembles cryptocurrencies like bitcoin or Ethereum in some limited respects, but differs in important ways.

Instead of being a marketable asset with highly fluctuating prices and limited use, the central bank’s digital currency would function more like dollars and be widely accepted. It would also be fully regulated and under a central authority.

A lot of questions remain in front of an institution as big as the Fed will get into. But the momentum is growing around the world.

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

Indeed, a 2020 survey conducted by the Bank for International Settlements indicated that almost every central bank in the world has worked on at least these digital currencies. About 60% work on “proof of concept” testing, although only 14% have actually launched a pilot program or are in the process of developing it.

Along with the enthusiasm for a possible new horizon of the financial system, there was concern about the correct implementation.

Instead, proponents of the central bank’s digital currency cite multiple benefits. Among these reasons, the most important is to provide non-banking access to the financial system.

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

“New forms of digital money could provide a parallel boost to the vital lifestyles that remittances provide to the poor and developing economies,” Kristalina Georgieva, managing director of the International Monetary Fund, said in a recent comment. joint meetings with the World Bank. “The biggest beneficiaries would be the vulnerable people who send small remittances: those who are most at risk of being left behind by the pandemic.”

Potential digital currency losers include some financial institutions, both in the traditional banking and fintech sectors, which could lose deposits due to people putting their money in central bank accounts.

There are also privacy issues and integration concerns.

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

“The race for Digital Money 2.0 is on,” Citigroup said in a report. “Some have framed it as a new Space Race or the Cold War of the Digital Currency. In our opinion, it does not have to be a zero-sum game – there is a lot of room for the growth of the global digital board ”.

However, there has been at least the appearance of a race, and China is perceived as taking the lead early.

With the launch of a digital yuan last year, some fear that China’s limit could undermine the dollar’s status as the world’s reserve currency. Although China has said that this is not its goal, a Bank of America report notes that the issuance of digital dollars would allow the US currency “to remain extremely competitive … against other currencies”.

“The CBDC offers the benefits of improving monetary transactions without the side effects of cryptocurrencies,” wrote Bank of America economist Anna Zhou.

Several other nations have advanced in projects, after the Bahamas was the first with the Sand Dollar.

The Fed is currently working on a joint project with the Massachusetts Institute of Technology to assess the effectiveness of a digital dollar, although there is no specific timeline as to when or if the US central bank will move forward.

“There are many subtle and difficult political choices and design choices you have to make,” Fed Chairman Jerome Powell said in a recent CBS “60 Minutes” interview.

“We’re doing all this work,” he said. “We haven’t made a decision to do this because, again, the question is will it benefit the people we serve? And we have to answer that question well.”

In a working paper on the subject, Greg Baer, ​​CEO of the Bank Policy Institute, an industry lobby group, warned of a potential “downsizing” of the traditional banking system. He added that “the impact on economic growth could be significant – unless the central bank has assumed responsibility for lending or has become a regular source of funding for banks”.

“The way forward is currently uncertain, and design choices could lead to very different results,” Baer wrote. He noted the Fed’s caution and how it contrasts with the European Central Bank’s “more hasty” action.

The ECB goes ahead with its “britcoin” project, although it has said it will simply be a pipeline for banks acting as intermediaries for digital currency accounts.

“This ‘British currency’ would be linked to the value of the pound in order to eliminate its holding as an asset for profit. There could be an economic impact in the form of wider investment in the UK technology sector and lower trading costs for international businesses, “said Jeremy Thomson-Cook, chief economist at Equals Money.

“I think this legitimizes the belief that cash is on the dodo’s path and that the wider landscape of payments will be entirely online over the next decade, apart from accidental or quixotic spending,” Thomson-Cook said.

Even with the seemingly unsolvable movement toward digital currencies backed by central banks, US authorities seem determined to take their time.

Powell also said that the Fed will not act without the specific authority of Congress and said that there are multiple concerns that need to be addressed.

“While central bank CBDC initiatives are not meant to disrupt the banking system, they are likely to have unintended disruptive consequences,” said Ahya of Morgan Stanley. “The more widely accepted digital currencies, the more opportunities there are for innovation and the greater the potential for disruption to the financial system.”