Once upon a time, pegging fiat currencies to the greenback was the gold standard. But, the world is accelerating its path to digitization, and the demand for sovereignty-backed digital currencies has become stronger than ever.
CBDC as the New Paradigm
The International Monetary Fund (IMF) is now advocating for 80 central banks to adopt Central Bank Digital Currency (CBDC). How did the IMF go from warning about cryptocurrency to advocating for digital currency? Citing reasons for greater mobility in the money market, the IMF suggested that initiatives such as a digital U.S. dollar would help to grow a global digital payment system from a clean slate.
What is CBDC and its perks? In the current phase, many countries are experimenting with the concept of a digitized fiat currency issued by the nation’s central bank. Conventionally, remittance relies on slow networks and incurs expensive transfer fees. However, a coordinated digital currency can revolutionize the cross-border payment process — thus benefiting individuals, businesses and institutions all around the globe.
Digital Yuan Is Not So Far
China has trialed with millions of its digital yuan, also known as Digital Currency Electronic Payment (DCEP), in multiple cities including Shenzhen, Chengdu and Suzhou — and its usage has already reached $5 billion in June. DCEP will be accepted as a legal tender and will negate the need of paying interest.
Fan Yifei, the deputy governor of People’s Bank of China (PBOC), highlighted at a recent DCEP whitepaper press conference the rising cost of producing and storing physical yuan. As compared to physical yuan, digital currency provides “controlled anonymity” and more traceability, akin to tracking the movement of cryptocurrency using public wallet addresses.
In addition, digital currency can reduce the systemic risks posed by payment providers and banks. Developing countries, such as El Salvador, Ukraine and others, have also realized the significance of digital currency in providing sovereignty from the U.S dollar. But, guess who’s singing a different tune?
Do No Harm or Do It Right?
According to the latest report by the Bank of International Settlement (BIS), digital currency should be a concerted effort among countries (not a closed-door sale). BIS stressed that cooperation between institutions in terms of technology, market structure and regulations will result in interoperability in the various CBDCs. For instance, wholesale and retail CBDCs of two or more jurisdictions can facilitate cross-border access and settlement arrangements.
In fact, Bill Foster, a U.S. congressman and member of the House Committee on Financial Services has called for “international coordination and agreement” on the U.S. CBDC. BIS also proposes the need to abide by a “Hippocratic Oath for CBDC design,” with its premise to first do no harm.
On the flip side, issuing a digital currency has its accompanying risks. For instance, digital currency could undermine monetary policy, as well as exchange rate controls.
Once again, this issue boils down to the design of CBDC; retail CBDC can be used as a digital variant of central bank’s reserves, similar to Money Supply 0 (M0), to manage the nation’s money supply and monetary policy. What’s more? Retail CBDC is able to modify the current two-tier monetary system by removing the intermediaries.
The chair of the Federal Reserve, Jerome Powell, disagrees with the supposed benefits of digital currency. However, he came around and agreed that stablecoins may play a bigger role in the financial system with more regulation. Most importantly, he concluded that the United States should “get it [CBDC] right, rather than move quickly.”