Cryptocurrencies have laid the foundation for digital currencies, both decentralised and centralised. Central banks across the globe have taken notice of blockchain technology and have put a lot of resources into developing a viable, digital alternative to fiat currencies as we know them. However, this transformation is not an easy one and involves many risks.
Weighing up the risks to rewards and if central bank digital currencies (CBDCs) are worth it or not is Kevin Braine, Global Head of Research and Operations at Kroll. Kroll is a provider of services and digital products related to valuation, governance, risk and transparency.
Here, Braine explains how CBDCs are being developed and how with the pandemic catalysing digital transformation, CBDCs have a clear runway to trial the new currencies:
Cryptocurrencies have captured the imaginations of investors and tech enthusiasts for the past ten years but now it seems there’s another group falling to the seductive charm of digital money.
Central banks of almost all major economies are toying with the idea of a central bank digital currency (CBDC), if not taking practical measures to implement them. The Banque de France has been undertaking experiments for the past year into the practicality of introducing a wholesale digital currency, finding that CBDCs could promote innovation in financial markets and maintain central bank control through distributed ledger technology (DLT). Similarly, China has been trialing a digital version of the yuan since April 2020, which has now amassed up to 140 million individual users and is expected to become the first digital currency put into mainstream use by a major economy.
With this in mind, the future of payment seems destined to be digital; the main contention is whether this digital future should be run through national and international central banks.
There are distinct advantages to central banks, financial inclusion being one with the greatest impact. CBDCs could allow unbanked members of society to gain access to payment and saving services. Instead of relying on third parties, banks or digital money platforms, the central bank could distribute funds directly to citizens. For developing economies, directly distributing digital financial aid to its citizens could be transformative.
From an AML perspective, CBDCs would make money laundering far more difficult and increase the likelihood of identifying perpetrators. Each user of the currency would have a digital profile of their transactions that the central bank and regulatory bodies would be able to track for anomalies, ultimately helping to tackle terrorist and criminal funding.
However, many of the early trials undertaken have highlighted the great difficulty of introducing a digital version of a nation’s currency. Among the 80 or so countries pursuing CBDC studies, none have settled on the most practical technological framework. The Bank of England is still debating the possibility of whether to use the DLTs used by cryptoassets or develop a form of centralised technology which shows how unchartered this territory is for the banking sector.
Cyber security, both for individuals and nations, is a primary concern among those opposed to the creation of CBDCs. For the average user, credential theft through social engineering or advanced malware could be a concern. Alongside concerns for individual users of the currency, the technological structure of centralised currencies would be a target for terrorists and could be susceptible to natural disaster. If the kind of ubiquity that advocates of CBDC expect is achieved, any compromising of the CBDC framework of a major economy could have devastating impacts.
Use of cash has fallen year-on-year in the UK since 2010, with 2020 seeing the biggest drop of 35 per cent compared to the year before, evidently a result of the role notes and coins played in spreading contagion. Despite this, the Federal Reserve and the Bank of England are restraining their enthusiasm for their proposed CBDC frameworks. A central bank digital currency would have to be closely regulated, to prevent manipulation and operate on an extremely robust technological structure. Over eagerness to digitally revolutionise a nation’s central currency, may ultimately have an adverse effect on business and consumers.