Thursday, May 19, 2022

CBDC a cross country comparison

Ever since 2020, the concept of digital currencies has become quite popular. From decentralized cryptocurrencies like Bitcoin and Ethereum, to country backed digital currencies like CBDC, they have gone quite mainstream. Currently, countries like Sweden, China and India are talking about launching their version of CBDC. China has even launched one.

In this article, we will discuss digital currencies and how they differ across various countries. First, let us start with the basics, so every reader (be it amateur or expert) is on the same page.

What is the central bank digital currency (CBDC)?

A central bank digital currency (CBDC) is an electronic record or virtual token of the official currency of a country. In other words, it is the digital version of a fiat currency for a particular nation or region. It is an electronic record or digital token of the official currency and is issued and regulated by the country’s supreme monetary authority.

The popularity of cryptocurrencies has made the way for central bank digital currencies. Cryptocurrencies like bitcoin and Ethereum are decentralised, this means there is no governmental authority looking after it. Since currencies have always come under the purview of the ruler or government, this was the first time their authority was challenged. The use cases of digital became clearer with the popularity of these cryptocurrencies. So, even governments started launching their own versions of cryptocurrencies.

The main merits of CBDCs are that they promote financial inclusion and ease the implementation of monetary and fiscal policy.

The main demerits of CBDCs are that they are a centralized form of currency (unlike cryptocurrencies) and can erode the privacy of citizens.

CBDCs have an edge over cryptocurrencies as they are not volatile in nature. Many times we have seen how the prices of these cryptocurrencies have fluctuated. With CBDCs, there will be a government backing that will look after this price volatility nature of cryptocurrencies.

Many countries around the world are exploring the introduction and use of CBDCs in their economy.

How are nation states reacting to CBDCs?

Here we will talk about how different countries like China, Sweden, Russia are planning to ring their digital version of fiat currencies. Then we will try to do a comparison of all on the basis of various factors.

A study by the Bank for International Settlements (BIS) from January 2021 finds out that 80% of worldwide central banks are involved in CBDC-related research. The percentage of central banks that are undertaking experiments or proofs-of-concept is also growing. It is almost 50% now. 10% of the central banks surveyed are planning to introduce a generally available (retail) CBDC in the next three years and 20% in the next six years. So we can safely conclude that CBDC efforts are very dynamic and it will only increase in momentum within the next few years.

China- DCEP

Among all the other economies in the world, China is currently leading the race of Central Bank Digital Currency (CBDC). The country completed a pilot project of the DCEP, the formal name of its digital currency in September and is currently making it available for retail use on major e-commerce platforms within the country.

The Digital Currency Electronic Payment (DCEP) is a digital version of the yuan, China’s national currency. This CBDC is backed by Yuan deposits kept in China’s central bank. It has been under development for around more than five years. The current system dictates that banks will have to convert a portion of their Yuan holdings in virtual form. They will then distribute the digital currency among businesses and citizens via a mobile application.

The biggest reason why DCEP got introduced in the first place was to challenge the popularity and the legal status of existing decentralised cryptocurrencies. It is further proved by China’s current decision to ban the use of all cryptocurrencies.

The second reason why DCEP was introduced is because of its superior technology. The Chinese digital currency can be used as a payment mechanism. One does not have to keep cash or card with them to make payments. It is acceptable as legal tender, throughout the country which the other cryptocurrency certainly are not.

Payment firms like Alibaba Group Holding Limited’s (BABA) AliPay and Tencent Holdings Limited’s (TCEHY) WeChat are currently leading this change. With China’s crackdown on cryptocurrency and technology companies, a digital yuan fits in nicely with this transformation. This is because it serves the government’s needs to surveil citizens as digital tokens are easier to track than cash.

Furthermore, there is a good side to it. A digital Yuan will help Chinese authorities to bring its unbanked population into the mainstream economy, thus increasing financial inclusion. China has a big number of unbanked people. They do not have access to a bank, so a digital currency will make their participation more mainstream in the economy without having to introduce any government scheme or expensive banking products or infrastructure.

One more reason behind the introduction of the digital yuan is to end the US financial hegemony in the world and lift Yuan to the status of the dollar. After the financial crisis of 2008, the trust in the US Dollar has started to decrease. It was around this time when Satoshi Nakamoto anonymously published a white paper discussing Bitcoin, that can possibly replace the US dollar. The idea suited well with international bankers and economists too as they started discussing the possibility of a replacement to the U.S. dollar for international trade. The Chinese CBDC too has similar motives to make Yuan an international currency. As China is continuously replacing the US in many fronts (from Olympics to economy) it will be interesting to see how this CBDC will play a role in the same.

Another benefit of CBDC is that it improves the possibility and convenience of cross-border RMB payments. Bloomberg too mentioned how a CBDC has the potential to strengthen the international use of the RMB and thereby help to internationalize the Yuan. If the digital Yuan falls under capital tax according to cryptocurrency laws of countries, the internationalization of the RMB might not be successful.

At this point, it is not sure if the Chinese central bank will focus on the internationalization of the Yuan or on capital controls.

Sweden: e-krona

In March 2017, the Swedish Riksbank started its CBDC pilot project, the e-krona. A pilot is planned from 2020 until February 2021. Then, the Riksbank decides whether to continue with issuing the CBDC. The Swedish CBDC pilot project will initially focus on a non-interest-bearing CBDC.

The aim of the pilot project is to ensure instant payments at any time, along with offline usability, as mentioned in this report. Unlike China’s CBDC, Swedish e-krona would ensure anonymity. The only condition that comes with anonymity is that it needs to be in line with regulation if e-krona transactions are happening peer-to-peer. For the pilot project, the Riksbank is planning a two-tiered operational structure.

Only 20% of all the payments in Sweden are conducted with cash. There is a growing number of merchants that are expected to stop accepting cash in the future.

The deputy governor of the Riksbank, Cecilia Skingsley predicted that Sweden might go cashless by 2023 as Swedish businesses are not obligated to accept cash.

The Swedish central bank is also under threat from the private players who are entering the payment system industry. These firms are profit-oriented and thus in times of financial crises or instability might not take as sophisticated measures to ensure the functionality of payment systems as public institutions like the central bank.

Therefore the central bank is planning a CBDC as it would provide a robust alternative in times of financial crises or turmoil of private payment service providers, thereby ensuring the stability of the Swedish payment system.

The Bahamas: Sand Dollar

The Bahamian CBDC project is called “Sand Dollar”. It’s prototype had already begun in the district of Exuma in December 2019 and two months later on the Abaco Islands as well.

The national currency is called the Bahamian Dollar and it is kept at a 1:1 peg with the U.S. dollar. Bahamas, unlike China, has a large number of banked population. 80% of Bahamian adults have a bank account — compared to a global average of 69%. However, there are significant gaps in access to Financial Services as opening bank branches on remote islands is not always cost-efficient for banks. Also, the presence of stricter anti-money laundering (AML) and counter financing of terrorism (CFT) standards has made banking services more expensive in the country thus reducing citizens’ interest.

 However, this decline in bank branches was not met with broader adoption of electronic payments but a higher cash usage. Therefore, the primary goal of the Sand Dollar is to make digital payment services more attractive by increasing efficiency in the payment systems. CBDC of Bahamas will be a substitution of cash, it would save expenses related to storing and distributing cash.

Further, economic surveillance can also be improved by the implementation of a CBDC. As digital money, Sand Dollars will allow for surveillance. With the information obtained, the central bank of Bahamas can introduce better products for the allocation of money that will also allow for better tax collection and policy-making.

Eastern Caribbean Currency Union (ECCU): DXCD

In March 2019, the Eastern Caribbean Central Bank (ECCB) rolled out its CBDC project called DXCD. The ECCB is the issuer of the Eastern Caribbean Dollar (ECD). It is the legal tender in eight of the eleven member states of the Organisation of Eastern Caribbean States (OECS) that together forms the Eastern Caribbean Currency Union (ECCU). The islands that are a part of OECS are located in the Caribbean Sea and are inhabited by more than 1.4 million people. Since 1976, the ECD has been pegged to the U.S. dollar.

The economy of the OECS is not digital- 80% of payments are still carried out with cash or cheques. These two modes are both old and inefficient.

The aim of ECCB will be the digitalisation of payment with the introduction of Central Bank Digital Currency. Furthermore, it will work at financial inclusion, growth, competitiveness and resilience.

Russia: CryptoRuble

The CryptoRuble is the digital currency of Russia. It is currently in development and is commissioned by Russian President Vladimir Putin. No mining will be required as in bitcoin as it will be solely issued by the government. The first pilot group for the testing of the digital ruble was formed in June 2021 and includes 12 banks.

Vladimir Putin announced in October 2017 that Russia would be issuing its own state-sponsored digital currency called the CryptoRuble. The CryptoRuble is not formally launched yet. However, it began its testing phase in June 2021. The digital ruble will be issued by the Central Bank of Russia as a central bank digital currency (CBDC) and managed by the Russian government.

Many Russian banks including the Credit Bank of Moscow and Crimea’s Russian National Commercial Bank have expressed interest in testing out the digital ruble.

In 2022, the central bank might allow citizens to test the currency. The idea behind this CBDC is that CryptoRuble will help decrease costs within the financial system while increasing competition among banks. It should be noted here that Russia still does not recognize digital tokens or cryptocurrencies as legal tender.

One of the main reasons that are expected behind the formation of this CBDC is President Putin’s interest in blockchain. The transactions are encrypted, and therefore it is easier to discreetly send money without worrying about sanctions placed on the country by the international community.

This theory became more popular after the Financial Times reported in early 2018 that one of Putin’s economic advisors, Sergei Glazyev, mentioned during a government meeting that CryptoRuble suits the sensitive activities on behalf of the state. The accounts with other countries can be settled without worrying about the restrictions imposed on them. For the record, Glazyev himself was placed under sanctions by former President Obama. The restriction prevented him from trading in or travelling to America in 2014.

Another reason for Russian CBDC is that it can help in containing other cryptocurrencies that are beyond government control like Bitcoin and Ether. Russia is not a fan of cryptocurrencies, with Putin himself mentioning in October 2017 that cryptocurrencies were used mainly for crime purposes. So, this CBDC, much like its Chinese counterpart, will be used to counter the popularity of decentralised cryptocurrencies like Bitcoin and Ethereum.

CBDC a cross country comparison

CBDC a cross country comparison
CountryMain ReasonThe interest given on currency depositsTestingOffline usability
ChinaCounter popularity of cryptocurrenciesFinancial Inclusion of unbanked Chinese citizensNoYesYes
SwedenAlternative to Payment service provides robust digital currencyNot decidedYesNot decided
BahamasLessen the use of cash among CitizensFinancial Inclusion of unbanked citizensNoYesYes
Eastern Caribbean Currency UnionLessen the use of cash among CitizensFinancial Inclusion of unbanked citizensNoYesNo
RussiaCounter popularity of cryptocurrenciesUndertake cross border payment even if put under restrictionsNot decidedNoNot decided

The last word

The popularity of cryptocurrencies gave birth to central bank digital currencies. It will be exciting to see in 10 years’ time how each currency turns out to be. While some countries are doing it for financial inclusion, some to reduce dependency on cash while some to crush the popularity of existing cryptocurrencies, in the end, we will find out it also turned out to be competition among countries to come up with the best CBDC infrastructure. It will be exciting to see if the world gets the IMF or CBDCs or not.

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