Why digital currencies matter

All about cryptocurrencies – and why central banks are developing their own alternative

3 August 2021 James Pomeroy, Global Economist, HSBC

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The pandemic accelerated the demise of cash and boosted digital payments. But besides greater use of cards and mobile wallet payments, new forms of digital money have grown in prominence. Governments and financial institutions are showing interest in cryptocurrencies and central-bank digital currencies.

There may be more than 4,000 cryptocurrencies but many are not designed to be a means of payment so are not currencies in the traditional sense.

Some do aim to be a means of payment, but acceptance by retailers is not widespread; transaction fees can be high, processing slow and volatility deters their use. Instead, they have been adopted as a store of value, even though they yield nothing and have little practical use.

Stablecoins, whose price is pegged to assets such as the dollar or gold, have therefore grown in prominence. They are useful for overseas payments as they require no foreign-exchange fees and remove currency volatility, but trust in the network is key, and the spread of adoption has been slow so far.

Meanwhile a new use involves using tokens to store items – be it artwork, collectibles or tickets – as a non-fungible token that acts as a proof of ownership and authenticity. Beeple’s, ‘Everydays: The First 5000 Days’ was auctioned this year for more than USD69 million.

The world’s central bankers have watched this rise in digital-currency alternatives and the demise of cash. Developed countries want to ensure the safety, robustness and efficiency of payments systems while emerging economies are promoting financial inclusion.

Sweden – where cash is no longer universally accepted – and mainland China are most advanced in developing a central-bank digital currency that could, in theory, provide highly efficient and almost costless means of payment that could operate alongside cash.

The European Central Bank, Bank of Japan and several other central banks are exploring their own digital currencies, but there are many decisions about their design to be made. If private customers can hold digital currency directly with the central bank they may not need accounts at commercial banks. For now, such an approach looks unlikely.

Sweden is already piloting an e-Krona and the Peoples’ Bank of China last year asked more than 10,000 merchants to participate in domestic trials of its e-CNY. Both could issue digital currencies this year but each has opted for an indirect approach – issuing their currencies to banks or online payment service providers. Most people would notice no difference – though payments would be faster and essentially costless.

The e-CNY could become used outside mainland China, but renminbi internationalisation requires Beijing to relax capital restrictions further.

Although the Swedish and Chinese pilots suggest their central-bank digital currencies would not pay interest, an interest-bearing currency could be used to transmit monetary policy, including the possibility of negative interest rates.

There are economic impacts of millions of unbanked people worldwide gaining access to digital payments. It could help lift emerging countries’ growth by providing access to savings vehicles and credit, streamlining businesses, and increasing tax revenues while cutting crime.

First published 17th March 2021.

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