Major central banks world over are increasingly taking interest in the concept of digital currency and its underlying distributed ledger technology. The People’s Bank of China and the Bank of England have started exploring and researching the potential of central bank issued digital currencies (CBDC), while the Reserve Bank Australia has suggested the possibility of a digital version of the Australian dollar in the future.

There are a lot of questions surrounding the impact of CBDCs on monetary policy, credit creation etc which need to be explored and answered for this concept to become a reality. Furthermore, the security of such a system should be foolproof with no scope for error.

Speaking with EconoTimes, Shidan Gouran, Angel Investor, serial entrepreneur and organizer of The Blockchain Event, and Rik Willard, Founder and Managing Director of Agentic Group, shared their views on CBDCs, their security and impact on existing digital currencies such as bitcoin.

Gouran explained that governments would prefer to eliminate physical cash because it hinders their ability to manage money. He said that physical cash is expensive to produce and distribute, hard to trace, analyse and control, and emphasized that this is the reason why most of the underground economy is still powered by physical cash. In addition, it makes it even more difficult to control monetary policies like negative interest rates, he added.

“These initiatives provide an opportunity for governments to hasten a cashless society. They do this by implementing architectures that lead to electronic cash. These methods can be as cheap to transact and manage as physical cash is today for their end users”, Gouran added. “CBDC systems, which are inspired by system like Bitcoin, are currently being considered generalized frameworks where central banks maintain complete control over the monetary supply.  These systems rely solely on distributed ledger technologies maintained by partner organizations such as banks, local reserves and other organizations to handle the problem of double spending and auditing.”

Benefits for the banking sector

When asked about the potential benefits of CBDC for the banking industry, Gouran said that it will most benefit from the “new architectures” inspired by cryptocurrencies. He sees the banking sector and commerce benefitting from CBDC on two fronts –

• “One benefit is that money will be programmable. For example, it will be easy, fast and inexpensive for entities to program business actions based on events that route and settle accounts. CBDC will also happen with a significantly lower risk of third-party spoofing and theft. These benefits contrast to the systems that are currently in place.
   
• Another benefit would be the less expensive and more efficient inter-bank payments. The distributed ledger network greatly reduces the need for a large workforce of auditors and intermediaries such as correspondent banks and centralised network operators like SWIFT.”    

According to Willard, the best outcome of CBDC from the bank’s point of view will be “even tighter control over the money supply in addition to greatly enhanced AML/KYC and auditing tools”.

“Additionally, central banks will be able to do business directly with consumers and cut out local and regional players. This may be good from a governance point of view, but may also have consequences for consumers down the road such as decreased privacy in transactions and less access to credit because central banks don't lend out their deposits and creates a seemingly safer way to store money for consumers. If this leads to a decrease in commercial bank deposits that chokes their lending capabilities, it could possibly develop into a situation where credit availability becomes much more scarce”, Willard added.

Factor of Security

Frequent hacking attempts on the cryptocurrency ecosystems – Gatecoin, ShapeShift, TheDAO, to name a few – have put a question mark on the security of such systems and have highlighted the risks that customer funds are exposed to.

Willard explained that the hacks on crypto-exchanges basically happen at the “most vulnerable point”, that is, the wallet level -- unless of course, it is an inside job. According to him, the preferred use case for central banks would be “one of a trusted arbiter of value, a sort of modern "weights and measures" system. This is so the blockchain(s) deployed for them would not necessarily have a "last mile" component directly to consumers. However, they might link to several competing consumer coin "products" in the marketplace, which would then be used for purchases, exchanges, etc.”

“Conversations currently taking place with certain central banks are revolving around banks seriously considering their own internal "coin" behind a wall that will be linked to a number of "outside" coins. These coins will be exchanged in real time to other digital currencies to be used by consumers. Therefore, any given central bank's risk of being hacked would be minimized and with billions of digital wallets out there, the consumer would likely still have vulnerability issues”, Willard added.

Gouran believes that CBDC systems will be considerably safer and more secure than the existing electronic systems. He said:

“CBDC systems are more secure because due to the fact they are the ultimate account owner, they include methods to freeze and also reverse transactions. In addition, Know Your Customer will be a feature of the distributed ledger, which is presumably operated by trusted banks and other money business organisations who are part of the distributed ledger network. Due to the type of cryptographic attestations all parties use in these networks, the system will actually be significantly safer than the current electronic landscape.”

Impact on existing digital currencies

As to what will be the impact of CBDCs on existing cryptocurrencies such as Bitcoin, Ether, Litecoin, etc, Willard says it is too soon to tell.

“Essentially, since there would likely be no direct consumer component for CBDBs, almost any digital coin might be linked to a CBDB. From this perspective, they might usher in an era of unprecedented value creation by providing a solid peg from which a thousand currencies flourish. Conversely, if regulation turns in on itself, which has been known to happen, it might extinguish currency innovation. In my opinion, it is too early to entirely tell”, Willard said.

Gouran believes that CBDC systems and the extinction of physical cash will lead to niche currencies for participants in the underground economy.

“Although this is not the only reason why cryptocurrencies would experience growth, it is a very clear one”, he added.