The exponential growth in the values of virtual cryptocurrencies like Bitcoin, Ethereum, and others has caught the attention of governments around the globe. This is especially true in emerging markets (EM) such as Kenya, Ukraine, India and South Africa as they are proving to be the leaders in the mining, trading, and spending of cryptocurrencies. As noted by Chainanalysis, a software company, in a 18 August 2021 report, people in EMs are turning to cryptocurrencies to preserve their savings in the face of currency devaluation, send and receive remittances, and carry out business transactions.                                                           

A rose by any other name? 
However, cryptocurrencies are not the same as digital currencies. Cryptocurrencies remain virtual “tokens ”primarily used for payment transfers. And although, similar to fiat currency, their value is based on the levels of demand and supply, they have historically been highly volatile in their valuation. This is because, unlike fiat currencies, they are not issued or backed by a nation state or central bank. Cryptocurrencies are decentralised and not regulated by any governing authority. 

The idea that crypto assets are no different than any others when it comes to public policy is coming to the fore. Central banks, including the US Fed, the ECB, the Monetary Authority of Singapore and others, are discussing how to regulate them. The reasons for this pressing interest in regulation are manifold including uncertainty about the financial integrity and soundness of the cryptocurrency and how smooth payment transfers really are. Other specific public policy concerns are related to consumer protection, investor protection, data privacy, tax compliance, and the threat of illicit activities such as money laundering. Most importantly, given the growing size of the market (now approaching $2 trillion), there are growing questions about whether cryptocurrencies may hinder the ability of the central banks to maintain the stability of the financial system should there be a sudden “run” on this new asset class; it seems there have been some lessons learned from the 2008-09 financial crisis when the MBS and CDO markets collapsed and affected the rest of the financial system.

Some central bankers, particularly in developed markets like the US, view cryptocurrencies as a threat to the banking system because it may move deposits, loans and payments from the regulated banking system. This could increase banking sector instability and undermine the mandate of central banks to ensure wider financial sector stability. And there is also the perceived threat that these cryptocurrencies pose to the ability of central banks to conduct monetary policy, i.e. to control the supply of money in the economy so as to be able to respond to demand and/or supply shocks. As a result, central banks across the world are now examining how digital currencies would work in practice. 

The rights of the individual vs the collective? 
Would central banks’ digital currencies (CBDC) really be accepted by their populations, particularly given that many people in both developed and emerging markets do not trust banks? The use of CBDCs would completely change the role of banks, especially in emerging markets, since access to a commercial bank account is not universal in some EMs. The use of CBDCs would increase the influence of the central bank on everyday life as people opened accounts directly with the central bank. Since people would no longer have to go through an intermediary, they would become directly exposed to interest rate decisions; this may strengthen the impact of monetary policy, thus reducing interest rate volatility and perhaps also be more successful in reducing inflation. In EMs, CBDC accounts may also give people proof of income, thus improving their access to future loans. It would also help in their ability to build up savings with all the positive knock on effects this may have for the domestic economy.  However, in places like the US and across most parts of Europe, the integration of the banking system into everyday life is much stronger and people and businesses in those markets are able to build up the necessary histories to access credit and loans. There is also the issue of privacy; do people want an official body to know their spending habits? Does that put them at greater risk of fraud if that information somehow becomes known? Can CBDCs, as requested in the Monetary Authority of Singapore’s CBDC competition, be designed to protect users from loss or support the recovery of lost funds without compromising user identity? 

For emerging markets the arguments for turning to CBDCs may be stronger than in developed markets. The desire for anonymity and the mistrust many people in EMs have of their governments’ ability to prevent wild fluctuations in the value of the domestic currency may help explain why cryptocurrencies are so popular. However, a central bank digital currency is likely to be safer than being subject to the volatility of cryptocurrencies. According to the June 2021 Annual Economic report from Bank for International Settlement (BIS), the risk of CBDCs leading to  currency substitution, whereby a foreign digital currency displaces the domestic currency to the detriment of financial stability and monetary sovereignty of the domestic central bank, can be controlled. They state that a number of central banks see currency substitution – along with tax avoidance and more volatile exchange rates – as a key risk that they are addressing in their work on CBDCs.  However, when it comes to digital currencies and fiat currencies, as noted in a January 2020 paper by Erik Feyen, Jon Frost, and Harish Natarajanor, “there needs to be robust and secure ‘cash-in/cash-out’ functions between cryptocurrencies and fiat currency through physical agent networks. This is challenging if distribution networks, primarily mobiles, are not equipped to handle crypto-asset transactions, lack geographical coverage or are prone to cyber-attacks.” 

In some emerging markets, particularly those like Brazil, Mexico and India, where there are already significant numbers of unbanked (those not having any access to any banking services), having direct access to central banks would, in theory, promote financial inclusion. However, given that this access is only via the internet, and many people may not have access to the internet, it would still be exclusionary unless it is rolled out with supportive fiscal policies that would enable the expansion of internet access with appropriate anti-hacking software to those people.  This makes the case for CBDCs both a monetary and fiscal policy decision for governments as well as central banks.

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