(May 22): With people observing social distancing measures during the Covid-19 pandemic, a serious concern has emerged. Can the virus spread via physical money? One research seems to suggest so — tests conducted found that some notes and coins may carry as much bacteria as those present on the soles of shoes or even toilet seats.
In March, the World Health Organisation (WHO) confirmed that banknotes may carry the coronavirus for several days and advised the use of contactless payments instead. Amid the heightened hygiene awareness, digital currencies came to focus. Improbably, the Covid-19 crisis may have prompted central banks to expedite this development.
Recently, the head of the Bank of International Settlements (BIS) Innovation Hub Benoît Cœuré said “the [Covid-19] crisis has exposed the value of technologies which enable the economy to operate at arm’s length and partially overcome social distancing…The current discussion on central bank digital currency also comes into sharper focus.”
China leading the way
While the rest of the world has been discussing and analysing the benefits and costs of digital currency, China’s central bank — the People’s Bank of China (PBOC) — seized the moment and started a pilot test of the digital yuan, the electronic form of the renminbi with value equivalent to the paper notes and coins in circulation. It has since become the first major economy to introduce a central bank digital currency (CBDC), rolling out the pilot test in three cities, including Shenzhen, Suzhou, Chengdu and in the Xiong’an New Area.
Also known as digital currency/electronic payments (DC/EP), these digital yuan transactions can be made through smartphone-based near field communication (NFC), a technology which enables phones to interact with each other when in close proximity thus allowing digital currency to be exchanged without the internet.
Mobile cashless payments — like Alipay or WeChat Pay — have become a part of daily life in China. But the launch of the digital yuan — coupled with a recent call by President Xi Jinping for the nation to focus more on blockchain technology — exemplifies its continuous push to become the world’s leader in digital currency space. Moreover, digital yuan may even pose a threat to the dollar’s supremacy as an international means of payment. Mainland based English newspaper China Daily even went as far as to claim that “[China’s] digital currency provides a functional alternative to the dollar settlement system and blunts the impact of any sanctions or threats of exclusion both at a country and company level… It may also facilitate integration into globally traded currency markets with a reduced risk of politically inspired disruption.”
Pros and cons
While it may be too early to evaluate China’s experiment, central banks around the world are paying great attention to this development while carefully observing the pros and cons of digital currency.
The truth is, central banks have been studying the use of blockchain technologies for years. The Bank for International Settlements (BIS) views potential CBDCs favourably as they would be backed by the government, and the money supply would be controlled by the central bank. Furthermore, the early versions of the US stimulus bill also flirted with the development of a digital US dollar to disburse economic stimulus payments. Meanwhile, the European Central Bank has also recently released a working paper analysing the merits of its potential digital currency.
The pros are there. In 2016, the Bank of England conducted a study on the feasibility of digital currency and found that it could increase GDP by as much as 3%. The usage could also “improve the central bank’s ability to stabilise the business cycle.”
Following the rise of decentralised cryptocurrencies such as bitcoin, the need for a secure digital transfer of money has become paramount. While bitcoin’s extreme volatility and low transaction processing capacity hinders its ambition to become a global medium of exchange, digital currency issued by a central bank has a far greater potential to become a trusted medium due to inherent low volatility as well as the potential for greater efficiency and lower transaction costs.
CBDCs would also likely help monetary policy targeting money supply and enable access to real-time data regarding money demand. At the same time, blockchain could support faster, auditable, and in general more transparent interbank settlement systems at decreased settlement costs, while avoiding issues like single point of failure.
As societies become immersed in digital payment, central banks rolling out digital currency could gain the first-mover advantage. Any central bank ignoring the role of digital currency could risk losing relevance in the global economy.
Challenges to overcome
However, the transition to digital currency adoption needs to be carefully managed. One challenge to overcome is the potential shortfall in credit. As the head of Germany’s Bundesbank Jens Weidmann once argued, in uncertain economic times people may choose to put their money as digital currency in central banks instead of deposits in commercial banks as the former is more secure and holds lesser risk. With reduced deposits also comes a severe contraction of consumer credit, which would clearly harm the real economy. As central banks’ digital currency looks set to take on a bigger role in future, commercial banks would have to find alternative sources to replace the deposits.
The PBOC are aware of this shortcoming: They did not want the digital yuan to become a threat to the retail banking system. For this reason, they did not make it available directly to the public. Instead, the digital yuan will be used by the PBOC and commercial banks for settlement of transactions which may increase transparency of the Chinese banking system and create more stability.
PBOC’s playbook calls for implementation of a two-tier system — the central bank will create the digital currency and issue it only to large financial institutions and four largest state-owned banks that will further distribute it to China’s 1.4 billion citizens, just like the issuance of cash.
Another major challenge is privacy. Digital currency enables tracing of all digital cash in circulation and, thus, a person’s use of finances. While this considerably helps authorities to fight money laundering, terrorist financing and even tax evasion, it also facilitates close surveillance and control of individuals’ transactions. In countries where privacy is a great concern, this may lead to serious public opposition.
Even though the PBOC has promised to keep the balance between privacy and suppressing criminal transactions, it remains unclear how it can achieve a balance between these diametrically opposite objectives. Early reports hint at limits in the frequency and amounts involved in anonymous transactions.
As an improbable consequence of the Covid-19 outbreak, CBDCs were brought into focus and governments might have been prompted to expedite their development. Seizing the moment, China’s central bank made major steps toward becoming the first major economy to issue a CBDC. How other central banks follow suit will be something that markets will play close attention to.
Emir Hrnjic is an adjunct assistant professor at National University of Singapore (NUS) Business School and a co-founder of Block’N’White Consulting. The opinions expressed are those of the writer and do not represent the views and opinions of NUS.
