Over the past year, the digital currency revolution has picked up pace as the Covid-19 pandemic accelerated the digitalisation of goods and services. The landscape of digital currencies is no longer just speculative trading of Bitcoin and other cryptocurrencies.
As many as 86 per cent of central banks are now in various stages of research and development into "digital cash" or central bank digital currencies (CBDCs), according to a Bank of International Settlements survey in January.
For example, the Bank of England recently announced that it is looking into a digital version of sterling. In March, European Central Bank (ECB) chief Christine Lagarde concluded that a digital euro may materialise by 2025, following the ECB's public consultation.
And most recently, last month, the United States Federal Reserve, or Fed, initiated a detailed CBDC study as it considers the possible issuance of the digital US dollar.
In Asia, China has already piloted CBDC trials, while in Singapore, the Monetary Authority of Singapore (MAS) has been conducting advanced CBDC studies since Project Ubin started in 2016.
How might CBDCs shape the economy of tomorrow? We must first examine the concept of digital money to understand the interplay between CBDCs, commercial banks and the general public.
What are CBDCs?
The digitalisation of goods and services has reached a tipping point as more people adopt digital-first behaviours.
With technological leaps in areas such as cryptography and blockchain technology, it could be argued that the use of physical cash may be due for an "upgrade" in the digital age.
Most of us already conduct day-to-day financial transactions through digital means, whether it is through banking apps or e-wallets. The idea of digital cash, or electronic fiat currency, is hence not novel.
CBDCs are a form of sovereign digital currency issued by the respective country's central bank that is one-for-one exchangeable with fiat cash.
Such currencies hold the promise of a more inclusive, faster and accessible world of finance, although much more foundational work has to be in place before its full potential can be realised.
What are the different types of CBDCS?
There are two main types of CBDC models currently being considered by most central banks: a wholesale model and a retail model.
Wholesale CBDCs are used by financial institutions and corporates for settlement of trades in financial markets and supply chains, whereas retail CBDCs are used by individuals and businesses to pay one another for goods and services.
An example of a retail CBDC would be China's digital currency, the electronic Chinese yuan (e-CNY), issued by the People's Bank of China (PBOC).
The e-CNY is meant as a substitute for cash and is considered legal tender. Its value is equivalent to the corresponding paper currency and can be converted yuan for yuan. It is issued directly by PBOC and can be circulated to consumers via electronic wallets. Its usage is aimed at improving efficiency in digital payments and reducing the need for physical cash.
The impact
How will the issuance of CBDCs affect individuals, businesses, financial institutions and the economy?
The impact of CBDC adoption will depend on the chosen architecture by each country and its existing infrastructure for financial intermediation.
• Individuals and businesses
Retail CBDCs can spearhead financial inclusion for individuals and small businesses in developing markets and improve the banking process for easier and safer transfer of money.
Digital cash offers governments the ability to deploy fiscal payments efficiently and in a targeted manner to segments of the population. Governments can issue financial aid, rebates and subsidies directly to individuals and small businesses in underserved communities.
This could be a massive game changer for developing economies, particularly in South-east Asia where 290 million are underbanked without access to financial services due to poor infrastructure.
The issuance of retail CBDCs will help central banks achieve greater effectiveness with monetary policy changes as they can more directly incentivise consumer behaviour.
This will also increase the adoption of cashless transactions and payment services.
However, the direct line between consumers and central banks can also be a double-edged sword. Central banks will need to set up new frameworks and measures to manage the risks that come with holding customers' deposits in the form of CBDC, such as anti-money laundering and counter-terrorism financing. This is in addition to the role that central banks already play as regulators, and as they continue to manage monetary policy and tax regimes.
• Financial institutions and the broader economy
Wholesale CBDCs can be a boon for financial institutions that may face liquidity concerns, settlement risks, and the pressure of meeting cut-off times when it comes to high-value transactions.
If commercial banks can hold CBDC accounts in various currencies to facilitate payments, the process of carrying out cross-border payments may be simplified and expedited. In April, the MAS and BIS Innovation Hub shared a preview of Project Dunbar, which will develop new multiple CBDC models aimed at improving the interoperability, connectivity, speed, cost and transparency of cross-border payments.
However, a widely accessible CBDC may not be beneficial to all jurisdictions. For developed markets, where there is an established financial ecosystem with efficient retail payment rails, the costs of replacing the system may outweigh the potential benefits of CBDC.
A mass conversion into CBDCs could drain conventional deposits and lead to a disruption of existing commercial bank deposit funding.
There is no one-size-fits-all model for CBDCs. Central banks will need to evaluate the best fit based on their policy objectives, the country's regulatory framework as well as the sophistication of its financial infrastructure.
Policymakers will need to consider possible implications relating to interest rates, impact on financial markets as well as the possible risks that may be passed on to the central bank, such as money laundering.
CBDCs hold the promise of a more inclusive, faster and accessible world of finance, although much more foundational work has to be in place before its full potential can be realised.
To do so, there will need to be close collaboration between various private and public stakeholders and a receptive public.
One thing is for sure - the concerted exploration by central banks to develop CBDCs is a step in the right direction to keep pace with changing consumption behaviour and the way companies do business in the digital age.
Over the past year, the digital currency revolution has picked up pace as the Covid-19 pandemic accelerated the digitalisation of goods and services. The landscape of digital currencies is no longer just speculative trading of Bitcoin and other cryptocurrencies.
As many as 86 per cent of central banks are now in various stages of research and development into "digital cash" or central bank digital currencies (CBDCs), according to a Bank of International Settlements survey in January.
For example, the Bank of England recently announced that it is looking into a digital version of sterling. In March, European Central Bank (ECB) chief Christine Lagarde concluded that a digital euro may materialise by 2025, following the ECB's public consultation.
And most recently, last month, the United States Federal Reserve, or Fed, initiated a detailed CBDC study as it considers the possible issuance of the digital US dollar.
In Asia, China has already piloted CBDC trials, while in Singapore, the Monetary Authority of Singapore (MAS) has been conducting advanced CBDC studies since Project Ubin started in 2016.
How might CBDCs shape the economy of tomorrow? We must first examine the concept of digital money to understand the interplay between CBDCs, commercial banks and the general public.
What are CBDCs?
The digitalisation of goods and services has reached a tipping point as more people adopt digital-first behaviours.
With technological leaps in areas such as cryptography and blockchain technology, it could be argued that the use of physical cash may be due for an "upgrade" in the digital age.
Most of us already conduct day-to-day financial transactions through digital means, whether it is through banking apps or e-wallets. The idea of digital cash, or electronic fiat currency, is hence not novel.
CBDCs are a form of sovereign digital currency issued by the respective country's central bank that is one-for-one exchangeable with fiat cash.
Such currencies hold the promise of a more inclusive, faster and accessible world of finance, although much more foundational work has to be in place before its full potential can be realised.
What are the different types of CBDCS?
There are two main types of CBDC models currently being considered by most central banks: a wholesale model and a retail model.
Wholesale CBDCs are used by financial institutions and corporates for settlement of trades in financial markets and supply chains, whereas retail CBDCs are used by individuals and businesses to pay one another for goods and services.
An example of a retail CBDC would be China's digital currency, the electronic Chinese yuan (e-CNY), issued by the People's Bank of China (PBOC).
The e-CNY is meant as a substitute for cash and is considered legal tender. Its value is equivalent to the corresponding paper currency and can be converted yuan for yuan. It is issued directly by PBOC and can be circulated to consumers via electronic wallets. Its usage is aimed at improving efficiency in digital payments and reducing the need for physical cash.
The impact
How will the issuance of CBDCs affect individuals, businesses, financial institutions and the economy?
The impact of CBDC adoption will depend on the chosen architecture by each country and its existing infrastructure for financial intermediation.
• Individuals and businesses
Retail CBDCs can spearhead financial inclusion for individuals and small businesses in developing markets and improve the banking process for easier and safer transfer of money.
Digital cash offers governments the ability to deploy fiscal payments efficiently and in a targeted manner to segments of the population. Governments can issue financial aid, rebates and subsidies directly to individuals and small businesses in underserved communities.
This could be a massive game changer for developing economies, particularly in South-east Asia where 290 million are underbanked without access to financial services due to poor infrastructure.
The issuance of retail CBDCs will help central banks achieve greater effectiveness with monetary policy changes as they can more directly incentivise consumer behaviour.
This will also increase the adoption of cashless transactions and payment services.
However, the direct line between consumers and central banks can also be a double-edged sword. Central banks will need to set up new frameworks and measures to manage the risks that come with holding customers' deposits in the form of CBDC, such as anti-money laundering and counter-terrorism financing. This is in addition to the role that central banks already play as regulators, and as they continue to manage monetary policy and tax regimes.
• Financial institutions and the broader economy
Wholesale CBDCs can be a boon for financial institutions that may face liquidity concerns, settlement risks, and the pressure of meeting cut-off times when it comes to high-value transactions.
If commercial banks can hold CBDC accounts in various currencies to facilitate payments, the process of carrying out cross-border payments may be simplified and expedited. In April, the MAS and BIS Innovation Hub shared a preview of Project Dunbar, which will develop new multiple CBDC models aimed at improving the interoperability, connectivity, speed, cost and transparency of cross-border payments.
However, a widely accessible CBDC may not be beneficial to all jurisdictions. For developed markets, where there is an established financial ecosystem with efficient retail payment rails, the costs of replacing the system may outweigh the potential benefits of CBDC.
A mass conversion into CBDCs could drain conventional deposits and lead to a disruption of existing commercial bank deposit funding.
There is no one-size-fits-all model for CBDCs. Central banks will need to evaluate the best fit based on their policy objectives, the country's regulatory framework as well as the sophistication of its financial infrastructure.
Policymakers will need to consider possible implications relating to interest rates, impact on financial markets as well as the possible risks that may be passed on to the central bank, such as money laundering.
CBDCs hold the promise of a more inclusive, faster and accessible world of finance, although much more foundational work has to be in place before its full potential can be realised.
To do so, there will need to be close collaboration between various private and public stakeholders and a receptive public.
One thing is for sure - the concerted exploration by central banks to develop CBDCs is a step in the right direction to keep pace with changing consumption behaviour and the way companies do business in the digital age.