As if traditional banks didn't have enough to worry about with the rise of fintech companies and cryptocurrencies, they now have to ponder a world in which central banks are issuing their digital currencies.
The move for the so-called Central Bank Digital Currencies (CBDC) has been gaining momentum in recent years. But 2020 has seen a rash of new announcements.
The People's Bank of China, the Bank of Thailand, and the central banks of the Philippines and the Bahamas have all made recent moves towards digital currencies. Even the U.S. Federal Reserve is tipped to join the pack and create a digital greenback as early as next year.
On the surface, this might not seem like such a big move. Today, businesses and consumers send each other money electronically without actually touching any cash. So, this money is digital too.
But these funds are settled inside the banking system, while any CBDC is a direct liability of the issuing central bank. Like cash and coins, exchanging digital currency may not require a third-party financial institution to record the transaction or hold the currency in any way as its ownership is transferred.
Advocates of the CBDC concept say it will help payments innovation, including blockchain technologies, which can facilitate payments outside of the banking system. A CBDC would be a costless and immediate system of exchanging funds, and advocates say it would be secure and stable, and accrue interest like other securities issued by Governments.
Incumbent banks see hidden dangers
The potential for disintermediation in this scenario is enough to send alarm bells ringing in traditional banks. They will have to work hard to reinvent how they can add value in this new world.
At the very least, digital currencies should deliver lower international trade and settlement fees. Banks currently charge fees to "store" client funds, but this function could be mostly rendered superfluous.
For corporate treasuries, the implications would be significant. The whole idea of cross border payments and pooling funds in various accounts across the globe could be rendered obsolete, as the corporate treasury could potentially store the digital funds and disburse them directly with a few clicks of a mouse.
For consumers, the digital currency would be as good as carrying cash today. They would store the funds on their own digital wallets, most likely on their smartphones, and use them for payments as they use cards today, with the exception that there may not be a bank in the background.
The growth of the CBDC would be a significant move for the financial "establishment" as they seek to counteract the rise of cryptocurrencies outside of traditional money.
Different iterations of CBDC
In China, the People's Bank of China is pursuing its digital yuan pilot with an international and domestic strategy: the new currency can further the yuan's internationalization while at home. It can counter the rise of e-money provided by local fintech giants such as Alipay and WeChat Pay.
Not every central bank is rushing to issue digital currency. The Reserve Bank of Australia last week released a discussion paper on the subject and said it currently saw no compelling reason to do so.
Part of the RBA's rationale was that its policy aims, to push faster and more real-time payments, are already coming to fruition through the nation's New Payments Platform (NPP), which is growing in use and is fostering new innovation in payments. This, the RBA says, means that the likely demand for an e-AUD would likely be limited.
But while the RBA is skeptical about the argument for an e-AUD, it used the discussion paper to issue a warning to private companies — such as Facebook — which are trying to develop so-called "stablecoins" that can be used in e-commerce.
The RBA warns that if Facebook wants to roll out its Libra unit in Australia, it will have to back them with Australian currency or Government bonds.
The future is written in sand
The first central bank to issue a CBDC will be the Central Bank of the Bahamas, which will issue its new "Sand Dollar" in October.
Only around USD 48,000 in Sand Dollars will be issued, backed at 1:1 to the Bahamian dollar, which is pegged to the USD.
The Central Bank will issue more Sand Dollars as they are demanded, and at the same time, remove physical dollars from the system to prevent inflating the money supply.
It is a bold experiment and will be closely watched. No one can be sure how it will be received at this point, but it could just be the beginning of the future of money.
Image credit: iStockphoto/Urupong