Since its inception society always relied on trade. Initially by exchanging goods, then it was by using gold, silver or copper, sometimes even paying by salt, until pennies and paper came into circulation, with the earliest forms of currencies and money coming into use along with the establishment of central banks. Very recently, new mediums of exchange including a totally decentralised Bitcoin and projects, like for example a centralised Libra Coin, have also emerged. This however did not alter the officially recognised categorisation of money as yet. There are three existing types of money which can be distinguished as follows:
- Cash is the only recognised legal tender and is issued by the central bank;
- Bank money is issued proactively by commercial banks and represents a claim on the commercial bank for the pay-out of cash;
- Central bank reserves are issued by the central bank but are not available to the general public.
As important as having money it became equally important to have means by which money could be transferred instantly and in real time. Swift electronic payment became crucial. In recent years, the majority of central banks, both at national and supranational level, started toying with the idea of introducing a new type of currency, issued in digital form rather than paper form and on ledger technology such as blockchain. Known as central bank digital currency or CBDC, such digital currency would effectively have the status of legal tender, only it would be issued purely on a ledger technology and no ‘paper’ representation of such CBDC would exist.
Arguments in favour of using digital money instead of cash have geared further traction amidst the COVID-19 pandemic, not just for hygienic reasons, but also for the swiftness by which certain digital payment services allow a transaction to occur. In USA, during congressional debates on the Cares Act and the initial relief strategies to U.S. citizens, significant conversation took place surrounding the introduction of a central, digital U.S. dollar.
Proponents of CBDC see the currency as a solution to ensuring real-time transfer of value. True there are several services, operated either by financial institutions or payment service providers that enable a quick transfer of money from one account to another, however, payment in such cases would have to jump from one account to another and may be delayed, whilst with the use of ledger technology transactions would occur instantly. Another positive would be that CBDC can solve issues relating to discrepancies in reconciliation in central banks and on a wider scale with the collection of taxation.
However, there are several concerns regarding the manner in which CBDC may be adopted and its impact. For instance, if the European Central Bank (ECB) issued a Digital Euro, would the ECB opt for a private (permissioned) or a public (permissionless) blockchain? Can a currency operated by a central bank, albeit on a blockchain which in principle encourages the democratization of processes, operate on a public blockchain with unknown parties acting as validators? Could the integrity of the CBDC and its management remain intact?
Certain commentators have said that if CBDC was to be issued as a wholesale currency, meaning a currency that is used to clear settlement between financial institutions (CBDC: Considerations for the Digital Euro, dGen 2020) at a first glance, not much will change. The game changer would be if CBDC is issued in retail fashion, from central bank directly to private person or business. Can we end up in a situation where private persons and business open accounts directly with the central bank?
Could there effectively be a disintermediation process which would see financial institutions becoming redundant or will their role transform into service providers to central banks? How will the unbanked (1.7 billion of the world’s adult population and around 40 million EU citizens) be affected? What role will anti-money laundering laws play when opening banks accounts, will it be just to refuse a private person a bank account if we move to a purely cashless society?
There are also certain privacy concerns seeing as one central authority would effectively have in place one central ledger with mountains of sensitive data about the individual’s (and business’) transaction history. Essentially, a person’s activities would all be recorded and stored in one place and even trusted validators would have access to such data. It has been suggested that in certain transactions ‘anonymous CBDC vouchers’ could be utilised with a purpose to shield certain low transactions from AML checks and third-party validator access. Another presented solution is a technique called ‘Secure Multi-Party Computation’ whereby information pertaining to a transaction would be split up into parcels of information and validated by different nodes. Thus no one validator would have access to the information as a whole.
From a technical perspective there are also matters of scalability to be dealt with, with one solution being that an amount of CBDC is not issued directly from central banks but from financial institutions thus creating ‘synthetic CBDC’.
At present, there is also widespread concern that some countries might introduce a CBDC as a reserve currency at the expense of other reserve currencies. For instance, it is feared that the digital Yuan might challenge the US-Dollar as the world’s dominant reserve currency and likewise in Europe, the focus is also to protect the Euro from this effect. The international economic and financial impact, as well as social order, of introducing CBDC should not be underrated.
Adoption of digital assets, crypto currencies as well as CBDC if integrated intelligently will certainly fuel the digital economy creating a new standard of exchange. The uptake however needs to be based on trust and any trade-offs would need to be well assessed, essential, non-discriminatory, transparent and proportionate for a cashless society to be the lynchpin of the future digital economy.
Article by Dr Ian Gauci and Dr Bernice Saliba.
For more information please contact Dr Ian Gauci.
This article is not intended to impart legal advice and readers are asked to seek verification of statements made before acting on them.