The Rise of Digital Currencies among Central Banks

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The decline in the usage of cash for payments and aging financial transmission systems are two factors that are leading central banks to look for alternatives that solve both of these problems.  The question is whether or not cryptocurrencies in their current state will be the solution to these problems.

Central banks across the globe have been releasing reports detailing how digital currencies can enhance their country’s economic ecosystem, and debates have sparked regarding the pros and cons of using private digital currencies.  Central bank authorities have expressed concern as to whether issues like the security, volatility, and privacy could pose threats to economic stability.

The risks of using private digital currencies instead of fiat currency leads to the next major question: should central banks create their own digital currencies or use existing ones?  Creating their own digital currencies would allow them to customize the design to perfectly fit the needs of their economy. That being said, developing their own currencies could take years and cost millions, and the final product may not compare to the currencies developed by private companies. 

Over the past several years governments across the world have been discussing using digital currencies, but the conversation has become much more serious in recent months.  In the past month, news reports surfaced detailing Norges Bank’s, Norway’s central bank, research on digital currencies.  Norges Bank’s report focused on evaluating three main applications of a central bank digital currency (CBDC): the introduction of a reliable alternative to cash deposits in private banks, a suitable legal tender to replace cash, a replacement for electronic payment systems, and the effects on the availability of credit.

The Governor of Norges Bank said in a statement:

“A decline in cash usage has prompted us to think about whether at some future date a number of new attributes that are important for ensuring an efficient and robust payment system and confidence in the monetary system will be needed.”

The report, although promising for a fully digital economy, is inconclusive, ending with the following statement:

“It is too early to conclude whether Norges Bank should take the initiative in introducing a CBDC. The impacts of a CBDC – and the socio-economic cost-benefit analysis – will depend on the specific design. The design, in turn, will depend on the purpose of introducing a CBDC.”

Other European countries are in the process of conducting similar studies, with Sweden’s central bank considering transitioning their economy to use an electronic currency instead of cash. Switzerland’s government and banking officials have also been engaged in major discussions regarding the use of a national digital currency.

India, a country whose government’s friendliness towards cryptocurrencies is questionable, is also considering using digital currency.  The Reserve Bank of India (RBI) announced in April that they are looking into issuing its own central bank digital currency.  The RBI will release its report on its findings sometime later this month.

The US Federal Reserve has also been looking into the use of digital currencies but has not yet released any conclusive information on their findings. Recently, Sheila Bair, the former chair of the Federal Deposit and Insurance Corporation (FDIC) said that she thinks the US Federal Reserve Bank should consider using digital currencies to reduce the risk of a financial crisis and to improve monetary policy.  She specifically outlines how, what she calls, a "FedCoin" would work.  

The creation of a FedCoin would give the Fed significantly greater control over inflation and monetary supply than they currently have, as it would allow them to purchase and sell FedCoin’s on an open market in which it controls the majority of the supply.  Currently, the Fed controls monetary supply by buying and selling securities from institutions, and paying interest on the reserves that banks deposit with the Fed.  The current system is advantageous for banks, but not to individuals.  The FedCoin would be an interest-bearing coin that pays interest directly to the public, rather than to banks.  The Fed could control the economy by adjusting the interest rate on the FedCoin.  At times of economic strength, the Fed could increase interest rates, encouraging people to save.  At times of economic weakness, the Fed would decrease interest rates, encouraging people to spend their money, therefore stimulating the economy. 

Paper currency was first introduced more than 1,200 years ago in China, and the use of it seems archaic and unnecessary to many. In a world where it seems like all industries are going digital, it is only natural that fiat currency is the next thing to transition.  The transition from physical to digital currencies will not occur overnight, and could take years, or decades, to occur.  Nevertheless, government adoption will mark the crux of adoption for the cryptocurrency industry and would usher in a new era of success and growth for the industry.