Central banks edging toward money's next frontier in digital world

Frankfurt

MONEY is edging closer towards its biggest reinvention in centuries as central banks start to embrace the creation of digital currencies.

With modern technology and even the coronavirus facilitating a global shift towards cashless economies, and alternative concepts such as bitcoin taking hold, monetary policy makers are acting to ensure they don't fall behind. That might one day mean central banks could make currencies directly available electronically for people to spend with their smartphone, backed by the integrity of the state. Before that comes to pass, a power struggle will play out over the future of money, raising issues ranging from privacy to social equality and financial stability.

"The whole effort is defensive," said David Dollar, a senior fellow at the Brookings Institution in Washington. Central banks are "trying to get back into the key position to control currency and the money supply".

The most proactive country is China, conducting real-world trials of a digital yuan, partnering with the Swift global transactions system, and cracking down on payment services like Jack Ma's Alipay to reassert supremacy over its currency. Elsewhere, officials from Frankfurt to Washington are watching closely, pondering experiments of their own.

The idea behind central-bank digital currencies is that, unlike conventional electronic money, they aren't bound up with regular banks. Nor are they debts, as on a credit card. And they certainly aren't a privately created currency like bitcoin.

GET BT IN YOUR INBOX DAILY

Start and end each day with the latest news stories and analyses delivered straight to your inbox.

Sign UpVIEW ALL

They are cash - created by the state, just as notes and coins are - held directly in a citizen's electronic "wallet" or phone app. There is no financial middle man.

"If you look at the history of money, you had Phase One with the gold and silver coins of the Greek Islands, Phase Two was book money with the Amsterdam Exchange Bank, Phase Three was banknotes," said Wouter Bossu, deputy head of the International Monetary Fund's Financial and Fiscal Law Unit. Central-bank digital currency would be a "fourth form of money in human civilisation".

That idea is conceptually different to a so-called cryptocurrency like bitcoin, which is too volatile to be a store of value and insufficiently widely accepted to be useful for payments. It's more in the realm of a speculative asset. Likewise, tools such as Alipay are intermediary platforms for payment, not currencies in their own right.

In Shenzhen, the tech metropolis in southern China, citizens have already been testing out a trial digital yuan at Walmart, petrol stations and convenience stores. In October, the central bank distributed the experimental currency via a dedicated smartphone app, which recipients use in a similar way to existing electronic payments.

One challenge confronting policy makers is that such a system offers less privacy than cash or other digital payments. That means weighing citizens' discomfort about the ability of governments to track transactions against the legitimate need for authorities to stop money laundering and other financial crimes.

Even in China, privacy is a lingering concern. The People's Bank of China has discussed allowing "controllable anonymity" - meaning user transactions would not be generally known to each other but could be visible to the central bank.

Such invasiveness would hardly be tolerated in Europe or the US, where policy makers such as European Central Bank President Christine Lagarde are considering their own options. The ECB has explored the possibility of "anonymity vouchers", allowing users to privately transfer a limited amount of digital currency over a defined period of time.

Another pressing issue is access. The need to use a smartphone and the Internet to spend such money could leave poorer people disadvantaged. "Users need to have access to digital technology," said Catalina Margulis, a lawyer for the IMF. "If universal access cannot be ensured by the state, it would raise fundamental questions about proportionality, fairness, and financial inclusion if CBDC acquired legal tender status."

An even more existential question stems from the banking system's structural reliance on deposits of income and savings. Until internet payment giants like PayPal or Alipay came along, normal financial institutions were often the only conduit for everyday transactions.

A digital currency issued directly by the state however wouldn't necessarily use commercial banks, and that prospect is causing jitters.

In the euro area alone, lenders are sitting on some 11.4 trillion euros (S$18.3 trillion) of household and corporate deposits, representing about a third of their funding. Migrating even a small portion of that to a central-bank currency would risk the stability of the banking sector and its ability to make loans to the economy.

"If you give easy access to central bank money, in an unlimited and seamless way, that can have an adverse effect on bank deposits," said Benoit Coeure, former ECB Executive Board member and now head of the Bank for International Settlements' innovation hub in Basel. BLOOMBERG