Why are Central banks interested in digital currencies?

Why are Central banks interested in digital currencies?

By bit.team

According to the Bank for International Settlements (BIS), 86% of central banks are exploring this possibility. Some are more advanced than others. It is clear that states feel increasingly threatened by the impressive achievements associated with the alliance of finance and technology, and, above all, do not want to “miss” the train of digital currencies. They once missed the Internet train. Now they intend to strengthen their sovereignty, which fell after the advent of cryptocurrencies, by creating their own digital currencies.

In 2020, China decided to experiment with its digital currency in four major provinces. Its first goal is to test the digital yuan in full at the Winter Olympics next year. But the stakes are completely different. They are more strategic. China wants to fulfill a dream that has tormented it for a long time, namely to impose its currency as an international currency against the dollar.

European countries, including Lithuania, have also made good progress in creating their own digital currency. It was the first European country to launch its digital currency in July 2020. In Sweden, the central bank has also started tests.

Threats to central banks are no longer limited to well-known cryptocurrencies listed on Coinmarketrate.com, such as Bitcoin or Ether, but also much more serious, so-called “stablecoins”. These are digital currencies issued by private companies, the main characteristic of which is that they are supported by equivalent funds in conventional currencies, such as the dollar or euro, which indicates their stability, unlike conventional cryptocurrencies.

Legal vacuum

Central banks blame Bitcoin and cryptocurrencies in general for their decentralized nature due to the lack of unified governance. This is precisely the main counterargument used by supporters of cryptocurrencies, who rely on a libertarian philosophical and social approach to justify their use.

Enthusiasm for cryptocurrencies should not make us forget about the uncertainty and very real legal vacuum that surrounds them. Cryptocurrencies are part of the so-called “trust goods”: assets whose attributes cannot be estimated in advance by their buyers. Any failures are difficult to identify because they require extensive technical knowledge.

In fact, cryptocurrencies represent nothing. Cryptographic technologies allow you to create, store and transfer them. In case of problems, such as the theft of your cryptocurrency, the same technology should allow you to verify the validity of the process. Therefore, sometimes it is difficult for an ordinary person to understand the intricacies of this market, even for standard operations: buying, storing or selling.

The advantage of creating a CBDC will be to eliminate this legal vacuum. and reassuring players in this very specific market. In addition, the asset can allow companies and individuals to hold deposits with the central bank, which is encouraging for them, especially in a crisis situation. However, until now, these operations have been reserved only for commercial banks and certain financial institutions.

This is the real essence of the Central Bank’s digital currencies. Therefore, it would be more reasonable to talk about new means of payment than about a real new currency. Their main goal is not to lose control over the financial system and cash flows, and only then to make monetary transactions more flexible, without having to endure the negative side effects of cryptocurrencies, in particular excessive volatility, or their use in fraudulent transactions. However, this opportunity, provided to companies and individuals, is fraught with a number of problems.

Increasing the influence of central banks

In normal times, central banks lend money to commercial banks, which must inject it into the economy through loans to businesses and individuals. In reality, the process is more complicated, and sometimes, especially during a crisis and increased uncertainty, banks are reluctant to lend to avoid reckless risks. The pressure tactics of central banks are limited and far from effective.

Strengthening the power of the central bank will increase citizens’ distrust of an institution that is already suffering from a significant democratic deficit. The emergence of digital currencies of central banks will allow these banks to more effectively influence real economic activity in their interests by establishing a direct link with all economic entities. This would simplify monetary policy while increasing their influence.

But at the same time, it would upset the already fragile balance between central and commercial banks. The latter will see that their power will not only be shaken (reduction of bank intermediation), which is not without prejudice to their profitability. They are threatened with complete disappearance. Financial technologies may also suffer from this situation for the same reasons as commercial banks.

However, the consolidation of the central bank’s power will increase citizens’ distrust of the institution, which is already suffering from a significant democratic deficit, since it is not controlled by any elected body. We can add one more, and not least, the problem associated with a conflict of interests, since the central bank becomes a judge, becoming its own regulator, and a party, acting as a bank intermediary.

Incredible efficiency during a crisis

Bitcoin will be less of a problem when it becomes a means of saving, like gold, that is, when it becomes less volatile. I must say that with the Covid-19 crisis, money “flows freely”. Central banks have not hesitated to flood the markets with immeasurable amounts of money. This has given a boost to Bitcoin turifarians, who rightly accuse central banks of manipulating currencies.

I must say that more and more people in the United States and in Europe have taken advantage of incentive plans to invest in cryptocurrencies. They don’t trust fiat currencies.

Money transfers from the government to people during the Covid-19 crisis would be effective if this money were directly deposited into digital wallets. But, cryptocurrencies are increasingly dominating.

The question arises, do CBDC blockchains threaten cryptocurrencies? In other words, how dangerous their appearance will be for cryptocurrencies in general, and for BTC in particular. The answer to this question can only be ambiguous. It is unlikely that all digital currencies of the Central Bank will use blockchain technology, since central bank officials are skeptical about the emergence of a system that is not very transparent to them, and especially without a gendarme ensuring compliance with the rules. And even if it is on the blockchain, it will not make it easier.

Will cryptocurrencies survive?

However, the blockchain allows you to store and transmit publicly available and secure information, working without a regulatory authority. Unless central banks use so-called “permissible” or “semi-open” blockchains that work on the basis of confirmation of authority. That is, where the blocks will be visible to everyone (reading is allowed), but cannot be changed in the sense of checking them (writing is disabled). Only authorized nodes, in this case central banks, can change them.

Technically, cryptocurrencies can survive the battle with CBDC because they don’t play the same roles. Cryptocurrencies can be a means of saving, especially when they become less volatile. They can also continue to play, but in reasonable proportions, their role as a speculative asset. It is difficult to imagine that they can be considered, at least in the short and medium term, as currencies threatening the Central Bank. On the other hand, CBDC may well play the role of a single and indisputable currency. Such a development is hypothetically possible, and depends on the development of legislation concerning cryptocurrencies.

One thing can be said with 100% certainty: a great currency war is coming. The fiats, which are so opposed by both sides, will be the first to fall. But fiat is really the money of freedom. But, it’s all an allegory. Great changes are coming.