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

Wall Street is approaching the idea that the next big disruptive force on the horizon is the digital currencies of central banks, although the Federal Reserve is likely to be a few years away from developing its own.

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

A digital dollar would resemble cryptocurrencies like bitcoin or Ethereum in some limited respects, but they differ in important ways.

Instead of being a negotiable asset with very fluctuating prices and limited use, the central bank’s digital currency would function more like dollars and would 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 enters. But the momentum is expanding around the world.

“A big step in introducing digital currencies from central banks (CBDCs) could upset the financial system,” Chetan Ahya, chief economist at Morgan Stanley, said in a report for clients. “Efforts to introduce CBDC are gaining strength, with 86% of the world’s central banks exploring digital currencies.”

In fact, a 2020 survey by the Bank for International Settlements indicated that almost every central bank in the world at least worked with these digital currencies. 60% work in proof-of-concept tests, although only 14% have completed a pilot program or are in development.

Along with the enthusiasm for a possible new horizon of the financial system, he has been concerned with achieving the correct implementation.

By contrast, proponents of the central bank’s digital currency cite multiple advantages. Among these reasons, the most important thing is to give people without a bank access to the financial system.

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

“New forms of digital money could provide a parallel boost to the lifelines that provide remittances to the poor and developing economies,” Kristalina Georgieva, director general of the International Monetary Fund, said in a joint meeting with the World Bank. “The biggest beneficiaries would be the vulnerable people who send low value remittances – the people most at risk of being left behind by the pandemic.”

Potential digital currency losers include some financial institutions, both in traditional banking and fintech technology, that could lose deposits due to people depositing their money in central bank accounts.

There are also privacy issues and integration concerns.

As the Fed and other central banks work through these logistical problems, Wall Street grows with anticipation about what the future holds.

“The race towards Digital Money 2.0 is underway,” Citigroup said in a report. “Some have marked it as a new Cold War of the Space Race or digital currency. In our opinion, it doesn’t have to be a zero-sum game: there’s a lot of room for the overall digital pie to grow.”

However, there has been at least the appearance of a race, and it is perceived that China is taking the first direction.

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

“CBDCs offer the benefits of improving monetary transactions, without the adverse 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 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 timeline on when or if the U.S. central bank will move forward.

“There are a lot of subtle and difficult policy choices and design choices you have to take,” Fed Chairman Jerome Powell said in a recent interview on CBS’s “60 Minutes”.

“We’re doing all this work,” he said. “We haven’t made any decision to do that because, once again, the question is will this 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 pressure group, warned of a potential “decline” in the traditional banking system. He added that “the impact on economic growth could be significant, unless the central bank also takes on the responsibility of lending or becomes a regular source of funding for banks.”

“Currently, the path to follow is uncertain and design options can lead to very different results,” Baer wrote. He noted the Fed’s caution and how this contrasts with the “most hasty” action by the European Central Bank.

The ECB is moving forward with its “britcoin” project, although it has said it will simply be a conduit for banks, which would act as an intermediary for digital currency accounts.

“This ‘britcoin’ would be tied to the value of the pound to eliminate its property as an asset for profit. There could be an economic impact in the form of wider investment in the UK technology sector and higher transaction costs. low for international companies, ”said Jeremy Thomson-Cook, chief economist at international business payments specialist Equals Money.

“I think this legitimizes the belief that cash is going the dodo’s way and that the broader outlook for payments will be completely online over the next decade, aside from incidental or quixotic spending,” Thomson-Cook said.

Even with the seemingly intractable movement toward digital currencies backed by central banks, U.S. authorities seem determined to devote their time.

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

“While CBDC initiatives by central banks are not intended to alter the banking system, they are likely to have unintended detrimental consequences,” said Ahya, of Morgan Stanley. “The more widely accepted digital currencies, the more opportunities for innovation and the greater the chances of disruption of the financial system.”