Digital currencies and cryptocurrencies are rapidly changing the nature of money itself. This will have big implications for foreign exchange, the functioning of central banks and the types of services offered by commercial banks.
Digital currencies hold great promise for the millions of people without a bank account, but there are also risks, including the possibility of macroeconomic instability.
Professor Eswar Prasad is the author of the next book, The future of money: how the digital revolution is transforming currencies and finance. In this first of two articles, he examines the role of central banks and governments. In the second room, he will examine the impact of digital currency on the financial sector.
PRASAD: The initial view that cryptocurrencies are a passing fad that will not affect the world of money or finance is quickly cast aside.
What cryptocurrencies like Bitcoin have shown us is that there are technological avenues for central banks to issue digital versions of their own currency in a relatively secure form and in a form that makes payments digital. widely available and accessible to the masses.
So, all over the world, we are starting to see a number of central banks that have already launched or are planning to launch trials of their central bank digital currencies.
The payments revolution
One effect of this is going to be in terms of payments. Domestic payments at the retail level are becoming increasingly digital, and the proliferation of central bank digital currencies is sure to push this considerably.
But the most important change will probably be cross-border payments, which are currently very expensive, slow and difficult to follow. The projects that many central banks undertake not only use retail versions of their currencies, but what are known as wholesale central bank digital currencies.
Essentially, these allow commercial banks and other payment providers to settle cross-border payments much faster and at lower cost. This is where the real advantage lies.
The end of money is in sight
EDGE: You said the era of cash is coming to an end. What do you mean exactly by that?
PRASAD: It’s hard to see physical currency having a viable future.
From a government perspective, digital currencies have many advantages. They are less prone to counterfeiting – any currency that leaves a digital trace is less likely to be used for illicit activities or to facilitate corruption. And that pulls a lot of economic activity out of the shadows and into the tax net, which can be a boon to governments in terms of tax revenues.
Governments also view digital versions of their currencies as a way to give even the poor and unbanked relatively easy access to a digital payment system. From a consumer perspective, having easy access to a digital payment system without necessarily having a debit card or credit card or bank account is definitely a big plus.
And for businesses, the prospect of not having to deal with cash, not having to worry about security issues, is a boon, especially if the alternative is a low-cost, government-provided digital payment system.
Considering Facebook’s wide reach and the enormous financial clout it has, one can very well see a cryptocurrency issued by Facebook moving many national currencies.
So I think there are a lot of benefits from just about every angle you can think of. Of course, there are costs too – losing money will mean we lose any prospect of anonymity in our day-to-day transactions, but that could be a price that many companies are willing to pay for the economic benefits of digital currencies. . . It is therefore very difficult to see cash remaining viable any longer.
A digital wallet with the central bank
EDGE: Does this mean that each person would have a digital account with a country’s central bank?
PRASAD: Digital money can take many forms; it can be something as simple as money loaded onto an app, like a prepaid debit card that you use for payments through your phone. But a more sophisticated version of a central bank digital currency (CBDC) is where, in effect, each of us has an account with the central bank, perhaps in tandem with a digital wallet that we can use. to transact using digital versions of the currency.
These digital wallets could be managed by a country’s central bank or even by a commercial bank. So in other words you can go to your bank and have a digital account like you currently do for your regular interest bearing deposit account but side by side you could also have a bank digital currency account central that you can use for transactions that pay no interest but allow you to use digital currency for payments relatively easily.
The main difference from an existing electronic payment system like a debit card or credit card is that you wouldn’t need to access any of these other payment systems. The government would essentially provide the service at no cost to the consumer and the business.
Cross-border transactions will be cheaper
EDGE: What would happen to exchange rates if you traded in two different digital currencies?
PRASAD: For now, the prospect is that most central bank digital currencies will only be available for home use. So since most cross-border payments for business and financial transactions are already digital anyway, this will not fundamentally change the nature of valuation between different currencies i.e. exchange rates .
However, it is possible that over time countries will start to feel more comfortable allowing their digital currencies to be used more widely outside of their country. In that case, you could have digital versions of, say, the dollar that is widely used around the world. Or maybe you could have digital versions of the Chinese Renminbi that are widely used in Asia. But I think the fundamentals of the international monetary system related to capital flows and exchange rates will not be fundamentally affected.
Cross-border payments will become less burdensome. This will help economic migrants to send remittances back to their country of origin; these remittances will become much cheaper and much faster to send home.
For exporters and importers, it will become much easier to make cross-border payments and track them in real time. So we will see big improvements in efficiency.
EDGE: But couldn’t big currencies like the renminbi and the dollar overwhelm small currencies? It could be much easier to just use the digital dollar instead of my own digital currency.
PRASAD: The proliferation of central bank digital currencies and even cryptocurrencies does not pose much of a threat to major global currencies. However, for the currencies of small countries, or countries with less credible central banks, there is an existential threat posed by the easy availability of digital currencies from central banks outside their home country. So we can certainly see a digital dollar becoming very widely accepted around the world.
But there is an even more fundamental concern. It’s not just the US government or the US Federal Reserve that issues the currency. If you think of cryptocurrency or a stable coin issued by a large corporation, such as Facebook, it can be seen that it is much more reliable than a national currency in many countries.
And given the wide reach of Facebook and the enormous financial clout it has, one can very well see a cryptocurrency issued by Facebook moving many national currencies. So yes, for many central banks around the world this is an existential threat.