The central bank’s digital currency is the next major financial disruptor

Wall Street is heating up for the idea that the next big disruptive force on the horizon is the central bank’s digital currency, even though the Federal Reserve will likely remain a few years away from developing its own currency.

Led by countries as big as China and as small as the Bahamas, digital money is attracting more attention as the future of an increasingly cashless society.

A digital dollar would resemble cryptocurrencies such as bitcoin or Ethereum in some limited ways, but differ in important ways.

Rather than being a tradable asset with widely fluctuating prices and limited usage, the central bank’s digital currency would function more like dollars and be widely accepted. It would also be fully regulated and under a central authority.

Countless questions remain for an institution the size of the Fed. But momentum is building around the world.

“An important step to introduce central bank digital currencies (CBDCs) could actually disrupt the financial system,” Chetan Ahya, Morgan Stanley’s chief economist, said in a report to clients. “Efforts to introduce CBDCs are gaining momentum with a whopping 86% of the world’s central banks exploring digital currencies.”

Indeed, a 2020 study by the Bank for International Settlements indicated that almost every central bank in the world has done at least some work on this digital currency. About 60% are working on “proof of concept” testing, although only 14% have actually started a pilot program or is in development.

Along with enthusiasm about a possible new horizon in the financial system, concerns have arisen about proper implementation.

Proponents of central bank digital currencies, on the other hand, cite multiple benefits. One of the main reasons is that people without a bank account can access the financial system.

There is also a speed consideration. Wire transfers, such as those provided to people by governments during the Covid-19 crisis, would be made faster and easier if that money could be deposited directly into digital wallets.

“New forms of digital money could provide parallel impetus to the vital lifelines that remittances provide to the poor and emerging economies,” Kristalina Georgieva, director of the International Monetary Fund, said in recent comments at a joint meeting with the World Bank. . “The greatest beneficiaries would be vulnerable people sending small remittances: those most at risk of being left behind by the pandemic.”

Potential losers to the digital currency include some financial institutions, both in traditional banking and fintech, that could lose deposits due to people putting their money in central bank accounts.

There are also privacy and integration concerns.

While the Fed and other central banks are solving those logistical problems, Wall Street is growing in anticipation of what the future holds.

“The race to Digital Money 2.0 has begun,” Citigroup said in a report. “Some have framed it as a new Space Race or Digital Currency Cold War. In our opinion, it doesn’t have to be a zero-sum game – there’s a lot of room for the overall digital pie to grow.”

However, there has at least been the appearance of a race, and China is seen as an early leader.

With the launch of a digital yuan last year, some fear that China’s lead could ultimately undermine the dollar’s status as the world’s reserve currency. While China said this is not its goal, a Bank of America report notes that issuing digital dollars would keep the US currency “highly competitive … against other currencies.”

“CBDCs offer the benefits of improving monetary transactions without the adverse side effects of cryptocurrencies,” wrote Anna Zhou, Bank of America economist.

Several other countries have continued projects after the Bahamas was the first with its Sand Dollar.

The Fed is currently working on a joint project with the Massachusetts Institute of Technology to evaluate the effectiveness of a digital dollar, although there is no specific timetable for when or if the US central bank will move forward.

“There are many subtle and difficult policy and design choices you have to make,” Fed Chairman Jerome Powell said in a recent interview on CBS’s “60 Minutes.”

“We do all that work,” he said. “We have not made a decision to do this because, again, the question is, will this benefit the people we serve? And we must answer that question correctly.”

In a working paper on the subject, Greg Baer, ​​CEO of the Bank Policy Institute, an industry lobby group, warned of a possible “weakening” of the traditional banking system. He added that “the impact on economic growth could be significant – unless the central bank also assumes responsibility for lending or becomes a mainstream source of funding for banks”.

“The way forward is uncertain at the moment, and design choices can lead to very different results,” Baer wrote. He noted the Fed’s caution and how that contrasts with the “more accelerated” action of the European Central Bank.

The ECB is continuing its “britcoin” project, although it has said it will simply be a channel for banks to act as intermediaries for digital currency accounts.

“This ‘britcoin’ would be pegged to the value of the pound to prevent it from being held as an asset to earn a profit. There could be an economic impact in the form of broader investment in the UK tech sector and lower transaction costs for global businesses, ”said Jeremy Thomson-Cook, chief economist at global business payments specialist Equals Money.

“I think this legitimizes the belief that cash is going the way of the dodo and that the wider payments landscape will be fully online within the next decade, barring occasional or quixotic spending,” Thomson-Cook said.

Even with the seemingly stubborn move towards digital currencies backed by central banks, the US authorities seem determined to take their time.

Powell has also said the Fed will not act without specific congressional authority and has said there are multiple concerns that need to be addressed.

“While central banks’ CBDC initiatives are not intended to disrupt the banking system, they are likely to have unintended disruptive consequences,” said Morgan Stanley’s Ahya. “The more widely accepted digital currencies are, the greater the chance of innovation and the greater the chance of disruption to the financial system.”