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EXPLAINER-Central banks eye digital cash to fend off crypto threat

Fri, 9th Oct 2020 08:00

By Francesco Canepa and Tom Wilson

FRANKFURT/LONDON, Oct 9 (Reuters) - The world's largest
central banks -- and even some of the smaller ones -- are toying
with the idea of issuing digital currencies.

These would allow holders to make payments via the internet
and possibly even offline, competing with existing means of
electronic payment such as digital wallets, online banks or
cryptocurrencies.

Unlike these private solutions, an official digital currency
would be backed by the central bank, making it "risk-free" like
banknotes and coin.

While most projects are still at an early stage, they have
switched into higher gear in the past year after Facebook Inc
announced plans to create its own virtual token and the
COVID-19 pandemic boosted digital payments.

A group of seven central banks coordinated by the Bank for
International Settlements set out on Friday how a digital
currency could function.

Here is what we know so far:

WHAT IS A CENTRAL BANK DIGITAL CURRENCY?

A central bank digital currency (CBDC) is the electronic
equivalent of cash.

Like a banknote or coin, it gives its holder a direct claim
on the central bank, bypassing commercial banks and offering a
greater level of security as a central bank can never run out of
the currency it issues.

Access to central bank money beyond physical cash has so far
been restricted to financial institutions. Extending it to the
broader public could have major economic and financial
repercussions.

WHY DO WE NEED IT?

Authorities say that a CBDC would provide a basic means of
payment for all at a time when cash use is dwindling. It would
also offer a safer and potentially cheaper alternative to
private solutions.

Their main fear is losing control of the payment system if
private currencies such as bitcoin or Facebook's
proposed Libra are widely adopted.

This could make it harder for authorities to detect
money-laundering and terrorism financing but also weaken central
banks' grip on the supply of money, which is one of the main
avenues through which they steer the economy.

For many emerging countries, where a larger part of the
population is unbanked, a CBDC could be a way to foster
financial inclusion and extend the reach of the central bank's
monetary policy.

WHAT WOULD A DIGITAL CURRENCY LOOK LIKE?

Here's where views differ.

A CBDC could take the form of a token saved on a physical
device, like a mobile phone or a pre-paid card, making it easier
to transfer offline and anonymously.

Alternatively, it could exist in accounts managed by an
intermediary like a bank, which would help authorities police it
and potentially remunerate it with an interest rate.

While the idea of a CBDC was born in part as a response to
cryptocurrencies, there's nothing to say it should use
blockchain, the distributed ledger technology (DLT) that powers
these tokens.

The People's Bank of China said its digital yuan would not
rely on blockchain.

WHICH CENTRAL BANKS ARE LEADING THE WAY?

The People's Bank of China aims to become the first to issue
a digital currency in its push to internationalise the yuan and
reduce its dependence on the global dollar payment system.

Major state-run commercial banks are conducting large-scale
internal testing of a digital wallet application, according to
local media reports.

Some private companies, such as China’s largest ride-sharing
app Didi Chuxing, are also participating in testing.

In Sweden, already the world's least cash dependent economy,
the Riksbank has also begun testing an e-krona.

The European Central Bank and the Bank of England have both
launched consultations on the matter while the Bank of Japan and
the Federal Reserve have so far taken a backseat.

WHAT ARE THE RISKS?

Central banks fear a massive migration to CBDC would hollow
out commercial banks, depriving them of a cheap and stable
source of funding like retail deposits.

In a crisis, this would make them vulnerable to a run on
their coffers as clients would prefer the safety of an account
guaranteed by the central bank.

For this reason, most designs envision a cap on how much
each consumer would be allowed to hold in CBDC and, potentially,
even a lower remuneration rate to reduce its attraction.

WHO'S BEHIND THE TECH?

Some central banks have hired major consulting firms to
develop pilot schemes. Sweden's Riksbank, for instance, has
partnered with Accenture Plc for tests on its e-krona.

But others, mostly in smaller countries, have tapped
cryptocurrency and blockchain startups.

Lithuania turned to Gibraltar-based blockchain firm NEM to
issue the first CBDC in the euro zone.

The Bahamas hired local tech firm NZIA to design and
implement its "Sand Dollar" CBDC platform while the Marshall
Islands turned to New York-based blockchain firm SFB
Technologies.

(Reporting by Francesco Canepa and Tom Wilson;
Additional reporting by Alun John in Hong Kong, Leika Kihara in
Tokyo, Bill Schomberg in London, Colm Fulton in Stockholm;
Editing by Lisa Shumaker)

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