Are Central Banks about to Join the Digital Currency Gold Rush?
Until relatively recently, digital currency was just a curiosity for most. However, in recent months, central banks around the world have become increasingly concerned about the power of cryptocurrency to erode monetary policy and impact their ability to control interest rates.
In November 2021, a New York Federal Reserve symposium exposed potential problems faced by central bankers in dealing with emerging digital technologies. The think tank looked at a variety of different developments, including new asset classes like crypto and stablecoin and new payment processing platforms.
The advent of fintech has created huge advantages for consumers, including reduced costs, improved transaction speeds, and easier access to banking services. Even with recent volatility in the cryptocurrency market, fintech will certainly continue to advance. New startups will capture larger and larger stakes in the finance industry, making central bank cash less and less relevant as time goes on, thus diminishing control of central banks over interest rates.
What Is Cryptocurrency?
Bitcoin was the world’s first successful cryptocurrency. Launched in 2009, it was described as a “new electronic cash system that’s fully peer-to-peer, with no trusted third party.”
Cryptocurrency operates via a decentralized ledger system called a blockchain. A blockchain is a digital system that stores data and is secured by encryption. When cryptocurrency transactions are completed, data from the previous block is copied to a new block. The new data is added, the block is encrypted, and the transaction is verified by miners in the network.
Bitcoin is a payment system that is beyond the control of any person, organization, or other entity, eliminating the need for third-party involvement in financial transactions.
Is Cryptocurrency Safe?
Just as investors have become increasingly interested in cryptocurrency, so have criminals. According to a report from the cryptocurrency news outlet Crypto Head, cryptocurrency crimes have risen by a staggering 312 percent on average annually since 2016. These crimes include everything from people falling for scams related to crypto investing to hackers stealing investors’ coins.
There are several steps crypto investors can take to mitigate risk, such as investing in a cold wallet. Since a cold wallet is an offline device that is not connected to the Internet, it is the safest place to store crypto investments.
As the world’s oldest and most commonly used crypto, Bitcoin attracts the most crime reports. Beyond digital crime, Bitcoin’s safety as an investment option is under constant scrutiny due to the scale and frequency of value fluctuations. While stories abound of investors making vast sums overnight, equally, many people have lost significant amounts of money investing in Bitcoin. Nevertheless, although Bitcoin may not be a particularly stable investment vehicle, many experts tout its safety due to the platform’s robust security technology.
Why Does Digital Currency Pose a Threat to Central Banks?
Worth somewhere in the region of $2.2 trillion, the cryptocurrency market is gaining critical mass. Central bankers are becoming particularly concerned about stablecoin, a nongovernmental digital token used for both domestic and cross-border transactions that is particularly popular in developing economies. According to Citigroup global head of banks research Ronit Ghose, central banks are viewing stablecoin in much the same way that taxi unions looked at Uber: as a threat and an interloper.
Held in vast reserves across the globe and used to price everything from steel to computers, the dollar is not going to disappear any time soon. However, cryptocurrencies and stablecoins have the potential to upend the markets because they are not backstopped by a government’s assets, meaning that a collapse or hack of stablecoin could send shockwaves as individuals and organizations clamor to get their money back, which could in turn spark widespread financial panic and a bank run.
What Are Central Banks Doing in Response?
While many investors are wary of digital currencies, they have been shown to increase financial inclusion, help bank the unbanked, and eliminate hefty fees for basic services like cashing checks.
In the United States, around 7 million households remain unbanked. Recognizing the potential of digital currency to reach the financially disadvantaged, Democrats proposed legislation for a digital dollar wallet called the FedAccount.
According to data from PwC, more than 85 percent of central banks are investing in developing digital versions of currencies, with China leading the charge. To date, the country has pumped more than $300 million into its digital economy ahead of a broader rollout in 2023. Meanwhile, the Federal Reserve, the European Central Bank, and the Bank of England are also investigating digital currencies. Sweden is tipped to become the world’s first cashless nation in 2023, with the implementation of its e-krona digital currency system.
Central banks are coming under pressure to develop their own digital currencies. Although the adoption of digital currencies is not yet widespread, the race is on to harden the battlelines between cryptocurrencies and traditional standbys like the dollar.