Central banks explore digital currency

Central banks ponder the introduction of digital currencyNew currency options

Since crypto-currency bitcoin’s successful transition from experimental concept to globally accepted currency with a market value of more than $10 billion, central banks have become interested in investing in exploring the potential of digital currencies for themselves.

Countries including the UK, Russia, Canada, Australia and China are now looking at options for creating their own digital currencies and, while research is at an early stage, there’s a general recognition that the introduction of digital currencies is inevitable.

Central banks are already assessing the risks and benefits of adopting a digital currency and are projecting how ditching cash for digital could affect a country’s economy and financial stability, as well as better understanding how systems could be put in place to defeat hackers, at the same time serving the needs of tens of millions of people.

Learning lessons from bitcoin

Obviously, bitcoin has set the benchmark. Launched online by an anonymous computer scientist seven years ago, the bitcoin currency uses an encrypted operating system – or blockchain – to link transactions and create a permanent record of each stage of the transaction. Banks could, theoretically, utilise a blockchain system in the same way.

Naturally, bankers are attracted by the notion of super-fast digital transactions that aren’t hampered by the cost of handling cash, and that can be tracked as they move through the financial system. Such transactions could cut risk and fraud and would use tech to transform current antiquated systems and back-office infrastructure.

For the banks, the downside is the anonymous nature of bitcoin’s use; the decentralised peer-to-peer network already in use by the dominant crypto-currency wouldn’t find favour with central banks and would have to be replaced with an alternative model.

Looking for a new paradigm

Fairly radical options are already under discussion. One would see customers bypass the traditional high-street bank altogether, dealing instead with the central bank itself – although, as you might expect, it’s a model that’s being resisted by commercial banks.

The issue of regulation is one of the primary concerns and would likely require cross-border cooperation to be successful. It would involve monetary authorities collaborating on the necessary regulations, perhaps facilitated by the IMF.

It’s thought that when blockchain technology begins to dominate financial transactions, central banks will move more decisively.

Changing the face of banking

Money is already electronically held and processed, but blockchain technology will enable people to ‘programme’ cash held in accounts so it can carry conditions about where and by whom it can be spent.

The use of digital currency could also benefit the developing world and emerging economies, too. Because these currencies are low cost and easy to use on electronic devices such as smart phones, they can enable wider access for billions of people who aren’t currently part of the banking system.

Although it appears inevitable that digital currency will be embraced by central banks, it’s also likely that there’ll still be a place for cash – especially in smaller denominations – at least for the foreseeable future. Government-backed digital currencies available to ordinary citizens at low cost could yet be some years away and there are many regulatory and security issues to be resolved in the meantime. But the fact that many central banks already have digital currency in their sights is, in itself, a sign of the times.

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