Throughout history, the development of monies and various forms of payments systems have helped make the exchange of goods, services and assets more efficient and secure.
The rapid spread of internet based commerce and mobile technology — supported by advances in encryption and network computing — has driven the development of several innovative technologies. Secure online payments systems (think PayPal) and mobile payments and transfer solutions (like M-Pesa) are changing the ways in which we pay for goods and services.
One of the most important recent developments is the emergence of virtual currencies (VCs). VCs are issued without the involvement or backing of a state.
Some VC schemes make use of ‘distributed ledger’ technologies. You may have heard about this; it’s called the ‘Blockchain’. This technology provides peer-to-peer secure transactions without using a central registry, as you can see in the graphic below. It has the potential to help minimise counterparty risk, reduce settlement times, improve contractual term performance and increase transparency for regulatory reporting.
You won’t be surprised then to hear that private sector interest in these new technologies has been growing. And regulators and policymakers aren’t far behind.
For example, R3 — a New York consortium of more than 50 of the world’s biggest banks — is currently investigating how to employ Blockchain technology in financial services. Commonwealth Bank of Australia, National Australia Bank, Westpac Banking Corp and Macquarie are all members of this R3 consortium.
And, as you can see in the table below, bank spending on this technology is expected to skyrocket.
Source: Aite Group
Bitcoin and digital currencies were created to bypass the control of central banks. But, ironically, the idea may be hijacked by those very central banks. Central banks across the world are considering replacing physical notes with their own digital currency.
Indeed, the Bank of England (BoE) and the Bank of Canada are already experimenting with two digital currencies, respectively the RScoin and the CADcoin (Project Jasper). For the moment the banks’ goal is solely to better understand the technology behind Blockchain. But once they totally understand and control the technology, what could be the consequences for our traditional fiat currencies?
Could it mean the end of cash? And what would a government-backed digital currency look like?
Central Banks and Virtual Currencies
Let’s call this new digital currency ‘BCcoin’.
Under the BCcoin proposal, citizens and businesses would be permitted to open accounts at the central bank itself, rather than depositing funds in commercial banks as you do today.
Historically, central banks have not taken deposits from the public, largely because the volume of record-keeping and customer contact would be overwhelming. But digital technology could easily accommodate very large volumes of financial transactions.
If currency could be accessed via smartphones and other handheld electronics, bank branches and ATMs would not have to be maintained. And the government would save nearly $1 billion annually by not having to print, store, transport and safeguard physical currency.
Nevertheless, at least during the early years, central bank digital accounts would likely initially permit depositors to convert physical notes, presumably at a 1:1 rate. This would accommodate citizens who were uncomfortable with modern technology, as well as those unable to afford consumer devices such as smartphones.
Allowing private accounts at the central bank would solve many problems inherent in the current banking system. The central bank would not be vulnerable to bank runs, for one. And tax collection would become much simpler, while tax evasion and money laundering would become prohibitively difficult…
Governments could also exit the business of providing deposit insurance, like Australia’s $250,000 Government Guarantee Scheme. And commercial banks would no longer have to engage in ‘maturity transformation’ (where financial institutions borrow money on shorter timeframes than they lend that money out). This would see an end to the mismatch between demand deposits and long term loans that can cause liquidity problems.
On the macroeconomic side, one of the main advantages would come from giving the government more control and understanding of the financial system. Indeed, rather than being updated by digital currency ‘miners’ in competition with one another, central banks would have the exclusive right to modify the algorithm of money creation.
Such control would permit better implementation of monetary policies, as well as a better understanding of the business cycle. In fact, open market operations (the buying and selling of government securities to expand or contract the amount of money in the banking system) would be superseded by direct manipulations of customer balances. This could be directly targeted toward certain geographical regions or a particular demographic of depositors…
And, like it or not, a central bank digital currency would solve the ‘zero lower bound’ problem. This means they would be free to reduce interest rates below zero to encourage spending and investment. When money circulates in the form of physical notes, negatives interest rates are difficult to implement because you can refuse to deposit cash into banks, opting for a home safe…or your mattress instead.
I’ve covered off the biggest benefits. But you should be aware that BCcoin also presents numerous threats for consumers, which makes people suspicious about this new technology.
Indeed, such centralisation could make the entire financial system even more vulnerable to hacking or sabotage (on Saturday, 6 August, nearly 120,000 bitcoins — about $US70 million — were stolen from Hong Kong-based exchange Bitfinex when it was hacked).
In addition, a central bank controlling and tracking a national digital currency would have immense power to observe and potentially control your finances. The government could determine how much currency you own, and on what and where you can spend your money. And without having to print bills and mint coins, a central bank would be able to hyperinflate in a costless manner simply by adding more zeros to accounts.
Finally, if the main innovation of digital currencies is to permit central banks to force interest below zero, the public might come to resent the technology or even prevent its introduction.
To conclude, a sovereign digital currency will have profound implications for the banking system. Among other impacts, it will narrow the relationship between citizens, businesses and central banks. And it will remove the need for commercial banks entirely.
However, our world remains dominated by the elite. And when we know that a transition to digital currency might come at a large cost for the US — because the dollar remains the world’s de facto reserve currency — the transition surely won’t happen tomorrow!
Charles de Riedmatten