“The central bank is a bank through which the state intervenes in the affairs of private banks and which, unlike them, can itself print the money it needs.”

K. Goeppert and K. Pat

Recently, cryptocurrency developers have turned their attention to such a criterion as stability, which was to some extent predictable. To counter the volatility of crypto assets, the so-called stablecoins were created, which were taken as the basis for the state crypto assets of the Central Bank. What you need to know about central bank projects and what is their purpose, we will tell you in this review..

The reason for the emergence of state cryptocurrency

To avoid wild fluctuations common to conventional cryptocurrencies, stablecoins are backed by assets, allowing them to be pegged to fiat such as dollars, euros and even yuan..

The rise in popularity of stablecoins can be seen as a payoff for the assets to which they are tied. But as they spread, central banks face challenges in controlling the money supply..

Some central banks, such as the People’s Bank of China, have already stated that non-bank issuers must necessarily have cash, not bonds or other securities as collateral, and keep it at the central bank, not private institutions..

Other central banks are considering issuing their own competing “digital currencies” known as CBDCs. They believe the rise in stablecoins reflects a market gap caused by the inability of the formal banking sector to meet demand for low-cost, hassle-free cross-border payment systems..

Based on this, central banks want to fill the void and slow the growth of non-bank competition by issuing digital government currencies to the general public. This may be easy to do because central banks already provide highly efficient digital real-time settlement services to the banks they control..

CBDC enthusiasts argue that there are other benefits as well: they will allow central banks to impose negative interest rates very widely when necessary and provide the market with unlimited safe assets. This paves the way for the release of government cryptocurrencies for global payments. But issuing a CBDC, by definition, would force central banks to do everything from handling public complaints and user inquiries to know-your-customer reviews and anti-money laundering. Due to lack of experience, there is no guarantee that they will be able to do this job cheaper and more efficiently than the mainstream banking sector.

Central Bank Digital Currency Concept

Several central banks have begun to explore the possibility of issuing their own digital currencies. This was driven by the success of new technologies in the financial sector, a decrease in the use of cash and the growth of digital currencies, and the introduction of CBDC will have implications for the role of the Central Bank and may affect financial intermediation..

The CBDC digital asset (according to banks) has the following characteristics:

  • Access to it is wider than to reserves;
  • Much more functionality for retail operations than cash;
  • Has a separate operating structure;
  • May earn interest under realistic assumptions by paying a rate that differs from the reserves rate;

The state cryptocurrency has the following advantages:

  • Available to the public without any restrictions and recognized as legal;
  • It can take various forms depending on the existing payment;
  • A legally recognized form of payment and represents funds of the Central Bank and the state.
  • The central bank directly guarantees the convertibility of the CBDC at par into cash or reserves;
  • The Central Bank may decide to pay the interest rate on CBDC liabilities in line with the interest rate structure of other government liabilities and broader Central Bank monetary policy and financial stability objectives;
  • Acts as a means of final regulation of taxes, fees, fines and private obligations;
  • More secure for transactions and deposits than commercial bank transactions;
  • Faster calculation;
  • Improves the efficiency and security of both retail and large payment systems. In the retail industry, the focus is on how digital currency can improve the efficiency of payments, such as point of sale (POS), online and peer-to-peer (P2P).

Monetary Policy Issues for Government Crypto and Its Disadvantages

However, in trying to understand the macroeconomic implications of the CBDC adoption, central banks are faced with a lack of historical experience..

Central banks fear that if the use of fiat money is significantly reduced, then the monetary policy of the central bank will depend on the policy of the e-money issuer, which could seriously weaken the transmission of monetary policy, as well as limit the ability of the central bank to act as lender of last resort..

The issuance of digital government currency by the Central Bank could hinder such competition if it is intended to be a perfect replacement for private electronic money..

The risk of being wrong on this issue is significant, so most central banks have to approach everything with caution. Depending on the CBDC model, central banks run the risk of either excluding commercial banks, which are a vital source of financing for the real economy, or taking on the direct risks and complications of banking to the masses. Challenges in running businesses that are new to them can undermine the public confidence that central banks rely on by allowing them to take unpopular actions from time to time, such as raising interest rates..

Conclusions and decisions taken in different countries

Central banks were forced to respond to the dramatic development of cryptocurrencies and the increase in the efficiency of payment systems. Many of them have embarked on research projects to explore the potential for issuing a government crypt. The benefits of Blockchain technology for improving public functions are becoming increasingly popular in some countries looking to attract investment in this area.

Cryptocurrency is a digital currency in which encryption techniques are used to regulate the generation of currency units and verify the transfer of funds, operating independently of the central bank. Central Banks have differently approached the conclusion about the potential benefits of the state crypt for their country. They also have different views on cryptocurrencies and Blockchain technologies..

The global financial crisis has done a lot to change the financial landscape and people’s confidence in the banking system. The rise of cryptocurrency is due to the fact that it offers an alternative way of storing money and making payments without relying on traditional banking system and government control. Cryptocurrencies are imperfect in their current form, but they can play an important role in global economic participation and protection from excessive government efforts..

Cryptocurrencies are challenging the traditional pillars of the financial system, and against this backdrop, central banks face the threat that individuals will be able to store, spend and move funds without relying on fiat currency. This is a huge threat to the traditional role played by the Central Bank in monetary policy, and therefore it is not surprising that analysis and forecasting of the possible consequences of the introduction of state-owned crypto assets in developed banks is gaining momentum..

Countries considering or experimenting with government crypt:

Ecuador

The Central Bank of Ecuador, which adopted the US dollar as legal tender in 2000, was the leader in issuing retail CBDCs (called “dinero electrónico”) in 2014 as an additional payment instrument. Users were allowed to open accounts with their identification numbers and transfer money between dollar and digital tokens via a mobile app.

The government pushed for this initiative as it could save on the cost of replacing old banknotes with new ones (about $ 3 million) and thus contribute to economic growth and poverty reduction. However, the retail CBDC initiative has been unsuccessful due to the limited number of users using retail CBDCs to purchase goods, services, or payments. Consequently, the initiative was terminated by deactivating the account in 2017.

Uruguay

The first hands-on experiment was carried out by the Central Bank of Uruguay in 2017-2019 as a six-month pilot study of instant payments and settlements using retail CBDCs (called e-Peso).

Using 20 million pesos and converting them into digital currency, the project included about 10,000 mobile phone users (without the need to connect to the Internet), 15 businesses (for example, shops and gas stations), ANTEL (a state telecommunications provider), as well as several fintech firms. and payment solution providers.

The study was completed without any technological difficulty, and the Central Bank of Uruguay concluded that the release of retail CBDC benefited from cost savings, financial inclusions, crime prevention and tax evasion, and customer protection, although the experiment was conducted on a limited scale..

Lithuania

The Bank of Lithuania examined its CBDC in the form of a DLT-based collectible coin in 2018 with the involvement of domestic and foreign fintech firms as part of the fintech industry development initiatives. Since Lithuania has adopted the euro as legal tender, the central bank is not allowed to release retail digital assets for wider use as legal tender. Thus, a plan has been announced to release digital collectible coins alongside physical collectible coins.

Although the central bank is of the opinion that financial institutions should not be involved in the services of crypto assets, the first international blockchain center in Europe was created there, and the central bank announced its plan to create a sandbox with the LBChain service blockchain platform..

People’s Republic of China

The People’s Bank of China (PBOC), the central bank of the PRC, established the Institute of Digital Money in 2017 and explored the possibility of issuing its state-owned yuan-pegged crypto through commercial banks in so-called two-tier systems..

Beijing has already announced that it is ready to launch, and that the digital currency can be integrated into the existing banking system by commercial banks operating the CBDC retail digital wallets and the general public can conduct peer-to-peer transactions like cash. Coins will use a distributed ledger in a limited way for periodic verification of ownership.

Tunisia

The Tunisia initiative was promoted directly by the government. DLT-based digital tokens “e-Dinar” (digital version of the Tunisian dinar) were launched in 2015 with the support of a Swiss company and local fintech firms. This is so far the first successful case of a digital coin issued by a government agency or the Central Bank in the world. Digital tokens are currently listed on the global crypto-asset exchange and can be used in Tunisia to transfer funds, pay for goods and services online, pay salaries and bills.

Marshall Islands

Another government-led initiative is in the Marshall Islands, where the US dollar has been the official currency as legal tender since 1982 and there is no central bank. In 2018, the government proposed introducing its own state-owned crypto asset called sovereign (SOV), which is the second legal tender to complement the dollar..

Parliament passed the Sovereign Currency Act in February 2018 to allow issuance. The main motivation behind this initiative is to prepare for the planned reduction in grants provided under the US Compact Trust Fund, set up by the US government to compensate Marshall citizens affected by nuclear tests conducted near the country after 2023 and to acquire new sources of income..

Venezuela

Venezuela is the only country to issue a government-funded digital coin. The digital coin Petro was issued in 2018 and is backed by oil from the country’s reserves. It complements the bolivar as legal tender. The main goal of issuing a digital coin is to circumvent the financial sanctions imposed by the United States.

US President Donald Trump responded to this initiative by banning transactions using this crypto asset.

Conclusion

If central banks can overcome the technical hurdles, government digital currencies can provide faster, cheaper remittances across borders and improve access to legal tender in countries where cash supplies are shrinking..

The World Economic Forum paper indicated that new currencies could offer retail investors safer places to save if it allows them to set up accounts with their central bank, and could lower price barriers that currently leave about 1.7 billion people without banking. services.

Some economists even argue that they could have made monetary policy more effective by allowing outright rollover of interest rates. For China, digital currency offers a possible way to keep up with and control a booming economy. On the other hand, it can also give the government an additional tool to control.

Ultimately, central banks can take responsibility for conducting customer due diligence, fulfilling anti-money laundering and anti-terrorist financing requirements, and providing tax information..

Disclaimer. The information provided is not financial advice and is presented for educational purposes. This post expresses the personal opinion of the author, it does not have to coincide with the opinion of the administration of 3commas.io.

Mike Owergreen Administrator
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