A blockchain-backed central bank cryptocurrency

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The Chinese Central Bank has already begun experimenting with digital cash that could eliminate the need for paper money. Currency is already digital, and has been for years. But the basic model of banking is largely unchanged. This is because the system is based on the notion that digital currency issued by commercial banks is convertible into paper cash, which is a central bank liability. This paper explores what would happen if central banks started to issue digital currency directly, and idea that China and other countries are currently exploring Fintech expert Ajay S.

Mookerjee believes that it would upend the traditional banking system. He argues that a switch to Central Bank Digital Currency CBDC would be safer for depositors because CBDC is a direct liability of the issuing central bank, not of a commercial bank , would eliminate the need for commercial banks to directly take deposits from consumers and households, render much of the physical infrastructure of banking redundant, enable more effective monitoring and regulation of the financial system, and prove more inclusive.

The digitization of credit and debit card transactions and the development of banking apps has moved many traditionally cash-based transactions into digital space. So far, the shift to digital has left the banking business relatively unscathed, at least in the West, where new players such as Paypal still rely on customers linking the service to their bank debit and credit cards. A few online-only banks have materialized, such as Chime and Nubank, but, again, these ride on existing rails.

Broadly speaking, though, traditional banks have adjusted well to the digitization of money. The impetus for more radical change is coming from China, whose central bank has been running an experiment with a form of cash called Central Bank Digital Currency CBDC , which it envisions as the cash of the future, ultimately eliminating the need for paper money.

In China, these services will be licensed to four state banks and three telecommunications companies, who will act as wallet distributors rather than cash depositories. Users will scan barcodes on their phones to make in-store payments or send money to other mobile wallets. By the end of September , the digital currency pilot had recorded around million transactions with million users.

E-Yuan will be fully rolled out during the Winter Olympics in February , and if bilateral agreements with foreign monetary authorities are reached, tourists and business travelers in China will be able to obtain a Chinese e-wallet on their own phones. It consists of time-stamped record blocks with encrypted transaction activity, continuously audited by all verified network participants.

Blockchain decentralizes the storage and trustworthy transmission of money. Although Blockchain remains slow and cannot yet support large-scale applications, the technology is expected to mature over the next three to five years and is likely to overcome its limitations. At a certain point, therefore, the existing digital infrastructure will be replaced, which will eliminate the dependence of new entrants on the resources and capabilities controlled by incumbent financial institutions.

In the traditional model of banking, some two centuries old, individuals or institutions receive money from investments or pay that they deposit with banks, which then use the money to make loans, setting aside i. Banks make a profit on difference between the largely short-term interest they pay to the depositors they market to and the largely long-term interest they receive on loans to business customers or investments in equivalent financial securities such as corporate or government bonds.

While regulation ensures individual banks lend no more than their overall deposits less reserve, it has bloated the level of credit in the overall banking system. When a bank makes a loan, the borrower deposits the proceeds in their account, which is then treated as a fresh deposit and, minus the reserve, lent out again. This multiplier effect fuels economic growth, but the new money supply created is in the form of risky credit. And, as the meltdown demonstrated, the cost of these defaults is ultimately borne by households.

The banking business carries several risks: borrowers may default, short term interest rates may be higher than long-term ones, and depositors may seek to withdraw more cash than is available for withdrawal. The risks are cushioned through equity capital, the possibility of government support usually through last-resort loans from a central bank , and retail deposit insurance schemes — all which come at a price. It will also be a direct liability of the central bank, just as paper dollars or yuan currently are.

It is this differentiation that largely explains why the CBDC is likely to disrupt the basic model of the banking system, which has always been based on paper cash or convertibility into it.

Paper cash is essentially a bearer IOU issued by a central bank, for the bearer to spend or put under the mattress at any given time. But CBDCs are direct liabilities of the central bank, just as paper cash is, which makes CBDCs a safer form of digital money than commercial bank- issued digital money.

The situation is equivalent to a scenario in which every citizen has, in essence, a checking account with the Central Bank. Their pay and investment payouts arrive in their central bank accounts, and they can keep cash in there, on which the central bank can, if it chooses, pay interest. With the central bank effectively becoming the sole intermediary for financial transactions, banks would no longer compete for retail or business cash depositors, success in which currently underlies much of their market value.

Instead, they will, essentially, all borrow wholesale from the central bank to finance their lending activities — the central bank thereby becomes the lender of first rather than last resort. With funding secured, inter-bank competition will be based entirely on the ability to recognize and price good loans and to bridge short-term and long-term interest rates efficiently, which will reduce the margins in that business to the benefit of good borrowers, engaging in value-creating projects.

Competition for customer deposits will be replaced with competition for distributing their electronic wallets with the most innovative and user-friendly solutions. People will no longer need outlets from cash, as well as fewer places to deposit cash or other valuables. In a CBDC world, all transactions could in theory be monitored with the help of data analytics and AI in order to more quickly identify banks that are struggling or are engaging in questionable transactions.

At present, financial regulators must rely on the reports provided by banks, which means that remedial action comes late and often at a greater cost. In addition, in a CBDC world in which digital bank codes are visible to the clearing institution, it becomes much easier for the authorities to identify the parties to a transaction, which greatly simplifies the detection of criminal activity and eliminates the black markets characteristic of countries that deal largely in physical money.

The cost of fraud to U. The switch also simplifies the execution of monetary policy—the central bank can immediately change supply by issuing or canceling codes in its own accounts. And by paying interest on CBDC holdings, however, the central bank can directly transmit monetary policy to households, instead of influencing commercial deposit rates through the rates it offers banks on their reserve accounts with the central bank.

Today, with money held in commercial banks, the policymaker can only influence consumer and business behaviors indirectly.

In the U. An unbanked Indian consumer with an Aadhar number and a smartphone could easily transact over a mobile app. This means that countries in the developed world will fairly easily be able to integrate people into the financial system who were traditionally outside of it. These changes stand to take out many of the costs and risks implicit in the traditional system, which was built at a time when customers needed secure branches to deposit bags of cash.

That has resulted in a trillion-dollar, 85, branch, operations and payments infrastructure in the US that employs 1. Beyond the unnecessary waste of the physical infrastructure, the system is slow and expensive: payments take an average of days to settle, and card processing fees eat up half of retailing profit margins.

With CBDC and central banks holding deposits, banks cannot overstretch customer deposits as they currently do, which will significantly de-risk the banking system. An even bigger impact could result from the lowering of default rates due to the precision of CBDC transaction data in monitoring the use of credit.

CBDC is not without its problems. One obvious risk is to privacy. A number of U. Other concerns revolve around the role of a central bank as a wholesale lender of first resort. State-controlled credit could potentially be susceptible to political pressure for sector-focused lending. Would there be formal criteria for determining which banks would qualify for central bank funding?

How easy would these be to manipulate in some way? Perhaps the biggest concern is with security, particularly cyber security. You can argue that the existing system, with multiple banks responsible for their own security, is exposed to more frequent but possibly more localized breaches of security. According to this logic, if the central bank gets hacked, then the whole system could be fatally compromised, although the risk of a breach actually occurring is perhaps reduced — given that a central bank would have the cyber expertise of its government at its disposal.

Essentially, the trade-off would be between recurring but manageable breaches and highly infrequent but catastrophic ones. A central bank would definitely be too big to fail. That said, the technology of the blockchain is highly secure and transactions are highly compartmentalized, which means that the central bank could potentially operate a highly distributed and compartmentalized system, thereby spreading the risk and consequences of any possible cyber-security breach more widely.

Indeed, the future use of blockchain for cybersecurity is expected to improve on the present situation. In my view, the move to low or no-cash economies based on CBDCs, whose sovereign monetary bodies compete on software-like features and costs, is inevitable. The new banking model will reach more people with better, faster services, and deliver credit to businesses on better terms, while preserving liquidity and efficiency in the capital markets.

Overall exposure to risk will likely be reduced and, while some degree of privacy may be lost, the benefits from protection against fraud and other crimes will more than compensate.

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Create an account to read 2 more. Economic systems. Read more on Economic systems or related topics Financial markets and Financial service sector. Mookerjee is also a senior fintech adviser to Warburg Pincus, a global growth investment firm. Partner Center.



Bitcoin is speculation, not money, and facilitates financial crime, peak central bank warns

Just 15 European countries are currently participating in developing a central bank digital currency CBDC. This digital currency is comparable to Bitcoin or Ethereum but is issued and backed by an official central bank instead of created on a decentralised blockchain. While some countries have already launched pilot programmes, the D-Euro proposed by the European Central Bank has only managed to elicit a lacklustre response. The technology behind the D-Euro, which will not be rolled out before , is conservative and more akin to a PayPal-like digital bank account than a blockchain wallet.

and $ trillion.2 Bitcoin remains among the most widely traded of the absence of a central bank's “backing” means that a cryptocurrency would not.

Central Bank Digital Currency and Digital Fiat Currency: What You Need to Know

As cryptocurrencies such as Bitcoin become an increasingly established part of the financial landscape, central bankers have begun to explore the broader potential of digital currency more seriously. With a flood of white papers, task forces, and workshops, central banks in New Zealand, the UK, Hong Kong, the EU, the US, and elsewhere are asking whether it makes sense to create their own digital money. Sovereign digital money may have many benefits but is not without its risks. As cash transforms into strings of ones and zeroes, what does the future hold for consumers and businesses? These days, central bankers worldwide are fired up about the idea of digital currency. Specifically, they are increasingly intrigued by the idea of central bank digital currencies CBDCs , which are essentially digital versions of traditional fiat currencies — think digital dollars. CBDCs can be confusing because most fiat currency — dollars, pounds, euro, yen, and so on — already exists primarily in electronic form. The rest is simply numbers on electronic balance sheets — digital dollars. However, this money is not what central banks are talking about when they talk about CBDCs.


Digital Currencies and Fintech

a blockchain-backed central bank cryptocurrency

This site uses cookies to deliver website functionality and analytics. If you would like to know more about the types of cookies we serve and how to change your cookie settings, please read our Cookie Notice. By clicking the "I accept" button, you consent to the use of these cookies. However, despite very high interest in central banks globally, it is important to note that in almost all cases, the research and experimentation is exploratory and does not signify that the central bank that is carrying out the research or experiment has yet decided to issue a CBDC. Unfolding right before us is a potentially momentous worldwide transformation of digital money and its use.

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The government is preparing to introduce a law to ban private cryptocurrencies such as bitcoin and launch a framework for an official digital currency issued by the Reserve Bank of India. The law will create a facilitative framework for creation of the official digital currency to be issued by the central bank, according to the agenda published on the Lok Sabha website on Friday. The proposal to ban cryptocurrency is among the 20 bills to be considered at the Budget session of parliament. In a recent note, the Reserve Bank of India RBI mentioned that it was working on developing its own digital legal tender that has the backing of the state. This is not the first time that the central bank has spoken about such an effort. While the RBI did mention about the need for a central bank digital currency CBDC , it added, for good measure, that regulators and the government continue to be apprehensive about the associated risks around cryptocurrency.


Europe’s best government digital currencies: Ukraine and Sweden

Cryptocurrencies are growing in popularity by the day and governments around the world are not oblivious to the trend. Many are considering ways to regulate, adopt or, in some cases, ban the digital currencies, while there is also growing interest among central banks to create a digital version of fiat, or traditional, money. What is a government cryptocurrency? Although it is not a formal term, government cryptocurrency is normally used to refer to a cryptocurrency that has been officially issued or endorsed by a country as legal tender. In , Venezuela because the first, and so far, only nation to issue its own cryptocurrency: the Petro. Another form of government cryptocurrency is when a country recognises an existing cryptocurrency, such as bitcoin or Ethereum, as legal tender.

Bitcoin, tokens, Ethereum, and stable coins oh my! including virtual currencies, cryptocurrencies, and central bank digital currency.

Inside Russia’s Plans For a Digital Ruble

Schmid , and Stefan Bochtler. Blockchain and other distributed ledgers go far beyond cryptocurrencies. They are becoming core banking activities and offerings.


But at the same time, it doesn't want to go all the way to creating a blockchain structure to create and trade the digital coins. The central bank said it aims to augment the exchange space with a digital form of the ruble in addition to cash and cashless money, while the digital form could combine the best features of the other two, supporting online transactions like cashless money and being used offline like normal cash. According to the regulator, retail clients could use the digital currency for purchases, transfers to individuals, firms and the state, tax payments, conversions to foreign currencies in e-wallets and as a store of value. In addition to the normal functions of money as a medium of exchange, firms could conduct transactions via smart contracts with households or the state. The state could enhance the efficiency of transactions by automating them with smart contracts and by controlling the efficiency of public spending.

According to a report by Caixin yesterday, the People's Bank of China PBOC completed a trial on 15th December in which it demoed how transactions and settlements might take place via a custom distributed ledger system. Elsewhere, the report went so far as to suggest the pilot digital currency could be connected to the Shanghai Commercial Paper Exchange, forming a "national platform for bank bill transactions".

The Federal Reserve building is seen in Washington, U. Jan 20 Reuters - Creating an official digital version of the U. Federal Reserve said in a long-awaited discussion paper released on Thursday. The paper made no policy recommendations and offered no clear signal on where the Fed stands on whether to launch a central bank digital currency CBDC , a digital form of cash in your pocket. The Fed said it would not proceed with creating one "without clear support from the executive branch and from Congress, ideally in the form of a specific authorizing law. The paper tiptoes around a subject that has sparked debate inside the Fed's top ranks, even as other central banks across the globe are exploring the adoption of digital currencies. Nevertheless, it sets the stage for the central bank to collect public feedback on the potential costs and benefits of a CBDC, which could ultimately advance legislation long-term.

The central bank digital currencies CBDCs space has been pioneered by a diverse group of countries. Sweden, with its distinctively low use of cash is a natural forerunner but other regions have recently made headway, too. Notably, the European Central Bank is powering ahead on the digital currency dossier.


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