Decentralized Monetary System And Central Banks Digital Currency: Can They Co-Exist?

At the time of their inception, the primary objective of digital currencies was to create an exchange mechanism that is universally acceptable. While the actualization of this goal is still far, the cryptocurrencies have had significant impacts on the financial sector. Their unprecedented success, especially Bitcoin's, has compelled human beings to reconsider the transactions between themselves and their banking institutions.

During the recently concluded ‘sovereign money’ referendum in Switzerland, the voters assertively refuted the proposal to stop fractional reserve banking and relinquish entire money-creation powers to the local central bank.

Interestingly, there were several discussions on virtual currencies throughout the electioneering period. Notably, cryptocurrencies were not among the choices in the referendum.

In the long run, the mere presence of digital currencies as an option is likely to instigate economies to eliminate intermediaries such as banks from their transactions. Surprisingly, this radical change will not be initiated by voters or crypto hobbyists.

Instead, the initial phase of the transformation towards a crypto-based monetary system will be executed by the central banks, as they struggle to remain active and relevant in an economy that has undergone a blockchain-driven revolution.

One of the objectives of Bitcoin, the pioneer cryptocurrency, was to deploy encryption techniques that enhance anonymity and prevent espionage, especially by governmental agencies. Therefore, the involvement of central banks is likely to stir nerves from a section of crypto enthusiasts.

Nevertheless, it is worth noting that the mass adoption of virtual currencies by governments and the subsequent enjoyment of their benefits will create competition among the digital coins, promoting their growth.

The introduction of smart contracts as a means of regulating exchange rates will simplify international trade. For instance, the current heavy reliance on the dollar as the reference for forex rates will not be a necessity. Consequently, the resulting stiff competition among cryptocurrencies will further boost their growth, especially in value.

The Criticism Of Central Bank-Issued Digital Currencies

As expected, the concept of a central bank-issued digital currency (CBDC) has been met with significant challenges and has thus struggled to penetrate the marketplace. In 2015, the Bank of England was on the vanguard of the research concerning the establishment of CBDCs.

Recently, its Governor warned of an impending financial crisis if the bank issued digital wallets to its clients who mainly constitutes of average citizens. By doing this, the governor said, that everybody will have rights similar to those afforded by the central bank to conventional banks. Several banks, including the Bank of International Settlements, have since reverberated these sentiments.

Evidently, the hostile response against the CBDC concept suggests that the central banks still wields power over this intense debate. Moreover, it is an indicator that it is possible to disintermediate banks from monetary transactions. Therefore, should this concept be approved central banks will be the best bet for opening digital wallets since they are profitable and considerably less risky than other platforms. Also, they facilitate transactions with fiat digital wallets.

The Problem – Banks

As mentioned above, the disintermediation of banks will involve the establishment of digital fiat currencies. This is because banks are the primary cause of the challenges facing the systems, mainly due to their dependence on old infrastructure that has many regulatory barriers.

In addition to being centralized, existing databases rely on COBOL mainframes which are incredibly slow and vulnerable to attacks. As a result of these inadequacies, the overall cost of the transaction is increased substantially, making them unaffordable at times.

According to Charles Cascarilla, the CEO of Paxos, the free movement of money on a global scale is inhibited by intermediaries, which are banks. Besides, banks also bear severe political implications such as the infamous financial crisis of 2008. Back then, governments across the world had to part with colossal amounts of money to bail out banks and save the global economy from crashing.

This unfortunate event changed the perception of several bankers, who now acknowledge that banks are the problem and cryptocurrencies are the ideal solution. The more significant challenge lies in effecting this necessary transition.

Implementation Of The Solutions

Initially, the best-suited deployment process would be using a step-by-step approach. The first round of CBDCs would be issued to established financial institutions (exclusive of banks), followed by corporate giants, then smaller enterprises and lastly conclude with individual investors.

Alternatively, a distinctive CBDC interest rate determined by the central bank can be introduced. Under this approach, the central bank would retain its regulatory mandate that currently involves the imposition of policy rates on bank reserves and the trading of government securities. A different CBDC interest rate simplifies the regulation of transfers involving banks and digital fiat wallets, as well as the smooth transition from banks to the decentralized system.

Recently, Sheila Blaire, a former boss at the Federal Deposit Insurance Corporation, stated that central banks could leverage the interest rate utility to boost or slow down the economy because it has the capability of influencing the monetary policy. This will directly impact the rate at which individual currency holdings grow, influencing the deployment of saving and expenditure incentives.

Nonetheless, it is highly unlikely that central banks in first-world countries will adopt this approach since they have deep relationships with commercial banks. It is also difficult to embrace a monetary system that is not inclusive of the current industry players. However, central banks in the developing world are lily to be open to this concept, since they want to loosen the firm grip imposed by the Federal Reserve Bank. Theoretically, the introduction of digital fiat currency would give them control over the monetary policy.

The deployment of virtual currency is not a surefire solution to the centralization menace. For instance, corrupt bureaucracies such as the Venezuelan government can use such projects to siphon public funds.

Despite these hurdles, the digital currency wave will eventually take over, bringing a lasting solution to all problems facing the existing monetary system. Regardless of the fate of cryptocurrencies, the acceptance of a system that has multiple currency choices is likely to display the inherent advantages of virtual money and therefore increase their usage in the contemporary society.