Central bank digital currencies are starting to become a reality
Sweden and Ukraine are just two of the countries that have begun projects to digitise their national currencies.
In October, Stefan Ingves, the governor of Sweden’s central bank, Riksbank, wrote in an economic note on the future of payments that a digital currency issued by the authority would be an “evolution, not revolution” in the way people use money.
Ingves acknowledged that the use of cold hard cash was dwindling in the country and that issuing a digital version of its currency, tentatively dubbed ‘e-krona’, was a logical step. Sweden has been working on e-krona since 2016. Although it remains in the testing phase, is one of the more advanced projects in play.
Such a currency, often referred to as a central bank digital currency (CBDC) or stablecoin, is pegged to the value of a national currency like the krona, dollars, or pounds. A CBDC bears similar hallmarks to bitcoin but crucially, it is issued – and ultimately controlled – by a central bank. “An e-krona would in this way contribute to reinforcing the Swedish krona as a means of payment in Sweden,” Ingves wrote.
Just a few short years ago, the notion of central bankers talking so favourably of CBDCs seemed far-fetched. Cryptocurrencies were anathema to regulators. But as bankers started to explore blockchain, the tech underpinning cryptocurrencies, as a way to improve transactions and processes, attitudes have gradually changed.
Central bank digital currencies are very much on the agenda, but their path forward remains unclear. According to research by Coinmarketcap, there are more than 20 CBDC projects in action, all at various stages, around the world.
One of the most recent is in Ukraine. In January 2021, the Ministry of Digital Transformation of Ukraine signed a Memorandum of Understanding and Cooperation to use Stellar, a blockchain protocol run by the Stellar Development Foundation, to build a platform for a Ukrainian central bank digital currency.
Denelle Dixon, the chief executive of the Stellar Development Foundation, says it will create a digital hryvnia - which has been the national currency of Ukraine since 2 September 1996 - and “introduce new partnership opportunities in Ukraine to businesses in the Stellar ecosystem”.
Stellar also recently began working with German bank BVDH to develop a euro stablecoin that would be issued on its blockchain.
In December 2020, the Italian Banking Association (ABI) launched a project with its member banks to evaluate and demonstrate the uses of a digital euro, also using blockchain technology.
“The aim of the initiative is to proactively contribute to public debate and support banks operating in Italy as they prepare for the future,” says Silvia Attanasio, head of innovation at ABI. “It doesn’t aim to anticipate the European Central Bank decision on the adoption of a digital currency, but rather to explore possible use cases and reflect on the implications of its possible implementation beforehand.”
The diminishing use of paper notes and coins and the increasing prevalence of mobile payments and apps have facilitated an important change among consumers. While talk of cash’s death may be overhyped, the reality is that more people are comfortable now with digital payments than ever before and it’s a trend that is unlikely to sway.
The launch of Facebook's Libra gave digital currencies a significant boost
In 2019, Facebook unveiled its Libra project, since renamed Diem, which would create a stablecoin whose value would be linked to a basket of currencies including US dollars, Singapore dollars, euros, pounds, and the Japanese yen. It has been a rocky road for them so far, and the project has lost several partners, including Stripe, along the way. It has attracted a great deal of scrutiny from regulators.
Facebook’s efforts, regardless of how they pan out, were a shot in the arm to stablecoins and digital currencies. That such a large company was interested in this field was evidence that it wasn’t going away, and banks and regulators began to take notice.
Libra, Diem, or any similar digital currency built and issued by a company (or a consortium of companies) could transform monetary policy. Sweden’s Ingves was cognisant of the threat such a currency competing with traditional currencies could present.
“If we were to find ourselves in a situation where the Swedish krona is no longer regarded as the most important currency alternative for making payments in Sweden, we could ultimately lose the possibility to conduct our own monetary policy and to provide the banks with liquidity in a crisis,” he wrote.
It is now clear to central bankers that they need to play a role in digital currencies moving forward.
Launching a central bank digital currency is more challenging than it might seem
Technical development of a CBDC is one thing, but deploying one in the market will be a different tale and there will be a lot of practical challenges, says Daniel Diemers, a consultant working in financial services and cryptocurrency. Diemers previously worked on PwC’s blockchain group and is now the founder of SNGLR Group, an investment and advisory firm for tech start-ups.
“I think the practical implications and implementation of that will be actually pretty difficult. It can only work in my view if basically all the banks in that country get forced or at least asked to adopt that central bank currency into their systems,” he said.
For small businesses adopting a CBDC, it only makes sense if their banks and payment providers will support it. If any one of these institutions does not support the CBDC then payments will fail.
“It comes down to political questions. How much power does the central bank have to force the banks to adopt it?” Diemers says.
Large scale launches of CBDCs will possibly require specific regulatory changes, not just to encourage their use but to ensure that a digital currency sits on the same legal footing as a traditional currency and is fully recognised as legal tender.
Christine Legarde, president of the European Central Bank (ECB), said in November during a virtual conference that the ECB would likely launch a digital euro in the next two to four years. Such a move by Europe’s biggest financial decision-maker would set the wheels in motion for a digital currency in Europe - but with regulators calling the shots.
“A digital euro will not be a substitute for cash,” Lagarde said. “It will be a complement.”