Three major difficulties faced by central banks in issuing digital currencies

Today, the global monetary system has entered an unusual phase, and the definition of money is undergoing a dramatic transformation.

At its peak, there were 200 national currencies, but now there are only 180. When a national currency becomes an international currency, it must determine exchange rates with other currencies. Outside of national borders, it must follow the law of supply. The demand for Bangladeshi currency in the international market is much smaller than that of the US dollar. It can be seen that political power, not labor, is the main factor in measuring the demand for currency.

This view was generally accepted in the 20th century and the first decade of the 21st century, but the emergence of Bitcoin broke this rule. Bitcoin has no political power behind it. It issues currency through mathematical design and settles transactions through a continuously updated distributed chain structure called blockchain.

Bitcoin successfully solved the problem of double payment of digital currency. It was quickly accepted by people because it combines multiple features such as currency, payment chain and messaging system. It can protect user privacy without intermediaries and ensure security through unique electronic signatures.

In less than eight years, the total number of Bitcoin wallets has grown to 10 million, daily transactions have increased to 200,000, and the market value has reached $6 billion and is still rising.

In addition to Bitcoin, there are as many as 600 currencies similar to Bitcoin that are designed with mathematical logic. Among them, four have a market value of $100 million, 10 have a market value of $10 million, more than 50 have a market value of more than $1 million, and more than 150 have a market value of more than $100,000.

Not only are market capitalizations rising, but their transaction volumes are also rising. It is estimated that by 2020, smartphone sales will reach 4 million units per day and digital currency transactions will reach 1 billion per day.

When everyone can send emails and social messages for free, currency transactions should be simplified. Because of this, the political concept behind currency is gradually fragmenting.

But switching from a cash-based currency issuance system to a non-physical payment system requires a big political leap. This requires each country's "interoperability" to reach the level of Bitcoin and other cryptocurrencies. This is where central banks are confused and face three major dilemmas. The answers to these questions also determine the future of central banks.

Dilemma 1: Cash-like reliability

All central banks create a lot of money. For example, the Reserve Bank of India has created more than 15 trillion rupees of base money. This cash currently constitutes 12% of the total money supply.

People trust money because it is, in their opinion, the best bearer asset. Money is limited by national borders, it is fungible and anonymous, and it is backed by a fiat currency.

Some currencies are also accepted abroad. In this case, how to restore the use of these large amounts of currency and replace cash with a digital currency library becomes the key issue. This means creating an equivalent and reliable electronic system for currency issuance and payment. This requires not only that every citizen must have electronic devices such as mobile phones, but also that they can use electronic devices efficiently.

In a country with 1.2 billion people, this is a huge challenge. It requires the country to have a highly accurate electronic identity verification system for citizens. Not only that - privacy issues also need to be resolved before people are convinced to enter the electronic payment system.

Even for a small country like Switzerland, digital currencies will not completely replace cash until 2025. Replacing the dominant currency, banknotes, is a big challenge for central banks. The Reserve Bank of India alone spent $5 billion on printing and distributing currency in 2014-2015.

If you include the overhead costs of bank branches, the country has invested a huge amount of money to maintain the traditional structure of cash. The intention of cashless is good, but in most countries, people are more difficult to accept this concept than to accept Facebook.

Problem No. 2: A structure that doesn’t work

The second fundamental problem is the existing deposit and credit system.

The current system is a dual central bank-commercial bank system. The central bank issues currency, and commercial banks pass it on to people through branches and ATMs.

A regular bank does not have a relationship with the central bank. Bank branches are just channels connecting consumers and the central bank. The central bank is like the operating system, and the branch network of commercial banks is like the hardware.

These two make up the banking system, but there is a big problem in terms of hardware. It exists because the central bank cannot directly contact consumers. So loans and deposits are made by bank branches.

But the branch-driven system is not perfect, and it survives painfully through a debt overhang. In the past four policy adjustments, the Reserve Bank of India has cut the repo rate by 125 basis points, but banks have only given their own users 60 basis points.

In India, this has led to prolonged economic stagnation. In this binary system, the central bank is only half effective—it must lead its partner commercial banks.

The situation could be worse. India's public banks face a situation of high asset pressure and inaction. Their market value is lower than their debt. A large number of malicious defaulters will only aggravate the situation.

This poses a serious legal risk to the monetary system. The Monetary Reserve wants to circumvent this problem by designing a bank that only makes payments. So far, the agency has issued licenses to 11 institutions, more than half of which are owners of telecommunications and payment applications. These banks exclude deposit and payment issues, but the credit problem remains unsolved.

The third dilemma: when to release

The People’s Bank of China announced plans to issue its own digital currency. However, the exact timeline and design of the currency were not announced. Will this be a license-free currency focused on user privacy, or a licensed currency focused on social order and security?

Will it guarantee full convertibility with other cryptocurrencies or will it have controls in place? Will it pursue proof of work or proof of stake or a combination of both? What dilution of monetary sovereignty will it tolerate in the face of the Triffin dilemma, the conflict between short-term domestic goals and long-term international agendas?

Will it set up a payment terminal for every citizen and bypass bank terminals? Will it allow direct issuance of currency through e-wallet downloads or in partnership with banks? Will it only issue to taxpayers? Will it be rationed monthly or weekly?

Even if these issues are resolved, the timing of the digital currency’s launch is a big question. Will it wait until everyone has a smartphone? Will it enforce free internet access throughout the country?

These issues are important not only for China, but for every central bank. It requires the political elite to make a historic leap. This is easier said than done. Mathematically driven currency is a completely new physical thing, and political forces may bring constraints.

The current experiment is the digital currency experiment in Ecuador, which has completely replaced physical cash with digital currency since January 2015. But it is not a new type of digital currency nor is it a bearer asset like cash. All currencies are recorded in the central bank's database. So it is not a currency that demands payment from the buyer, just like Bitcoin. The privacy issues of electronic identity have caused concern, but the Ecuadorian government has ignored this point so far. It also prohibits the use of cryptocurrencies such as Bitcoin.

In a country of 16 million people, 40% of whom are unbanked, it will take a long time to fully implement this big leap, especially for the elderly and illiterate. It is like an official version of M-Pesa (which has been successfully implemented in Kenya and some other African countries). But even a year later, Ecuador's system has not become a popular trend. Only 10% of the population has accepted it. Ecuador has a very troubled monetary history and now uses the US dollar as its universal currency.

This digital currency attempt is designed to prevent the economy from becoming more dependent on the dollar and to reduce spending on cash printing. It not only blocks individual monetary autonomy, but also gives the government absolute authority over taxation, inflation, and interest rates. Any country that wants to replicate its experiment must take all these factors into account to avoid a major backlash in public attitudes.

No one knows what will happen next, but the progress of history cannot be stopped. In the world we live in, P2P and value transfer ensure a more reasonable allocation of resources. Who will lead this technological revolution, the country, the technology giants or some low-key organizations? No one can give an answer, but at least we know that the change has begun.