How Traditional Finance Embraces Digital Currencies
The use of digital currencies by the conventional banking system poses a complex question: to adopt or not to adopt? On one hand, there’s a compelling urge to stay trendy and be perceived as innovators, but on the other, it presents considerable risks for the banking system and its consumers.
Until the mid-2010s, banks demonstrated minimal interest in digital currencies and blockchain technologies. However, the situation began to shift following the bull run of 2017 when the cryptocurrency market achieved a capitalization of $1 trillion, ushering in an era of ‘thawing'. Thanks to Bitcoin's success, which surged from less than $1000 to almost $20,000 within a year, ‘blockchain' started to generate interest and command respect. This period also saw the emergence of a new term – ‘digital assets'. Most financial institutions wanted to capture this new trend, though they were unsure of the appropriate approach.
During 2017, a multitude of international IT companies held an unprecedented number of presentations on the theme ‘What is blockchain and why banks can't ignore it anymore'. However, members of financial institutions' board of directors failed to see the benefits of implementing a public blockchain over a traditional private database. They questioned why they should invest resources in ‘some blockchain with its immutable data'. They felt that a regulated database, which allows the IT department to make adjustments even when it violates laws or client interests, was a more promising solution.
Central banks rejected formal declarations that Bitcoin and other altcoins were competitors to the US dollar or the classical fiat banking system. Nonetheless, their interest in stablecoins was hardly a secret. Eventually, they concluded that the adoption of CBDCs (Central Bank Digital Currencies) was unavoidable. This was primarily because ‘risky' stablecoins and other cryptocurrencies were garnering too much attention, causing a substantial outflow of deposits into digital assets.
Banks' use of digital assets
Post-2017 saw the advent of a genuine CBDC frenzy. Board members of central banks could see no other significant market technologies that could secure their position as ‘innovators'. Consequently, they began announcing plans for the implementation of CBDCs, despite a lack of demand from businesses or individuals.
However, the spread of the CBDC ‘virus' continued, eventually reaching pandemic proportions. We started seeing the emergence of El Petro, e-Peso, the digital Yuan, E-Hryvnia, and other prototypes of state digital currencies. Some central banks, using taxpayers' money, have spent years researching the feasibility of issuing their own digital currency (such as the USA, EU, and Great Britain). Pilot implementations are in progress in seven countries (including China, Saudi Arabia, UAE, Australia), a process that is expected to take years. Meanwhile, 11 countries have even progressed to a stage of voluntary-forced implementation.
Both businesses and individuals, particularly lawyers, view Central Bank Digital Currencies (CBDCs) as an infringement on democratic liberties and constitutional rights of citizens. However, when it comes to the government allocating funds to a technology that seems unnecessary to many, the views of legal experts or public representatives often get overlooked.
Viewing CBDCs from another perspective reveals several intriguing aspects. Central banks are attempting to implement state digital wallets (which are mandatory for citizens), presenting a challenge to stablecoins. This approach could potentially save them the expense of minting new money. Adding a few digits to the ledger of a CBDC would be significantly simpler and cheaper than producing physical banknotes with security features.
Nevertheless, this approach is a double-edged sword. In attempting not to hurt the opponent, one might inflict damage upon oneself. CBDCs could spell disaster for commercial banks and the entire banking system. With monopolistic control over citizens' CBDC wallets and every transaction, central banks could feasibly introduce lending and deposit services. They could increase their profits by reducing the interest rates and commissions that commercial banks receive. This essentially would lead to the usurpation of their earnings.
Aside from CBDCs, there are a few standalone attempts at other digital implementations. For example, in Singapore, the United Overseas Bank Ltd. as part of a pilot project, issued digital bonds amounting to 600 million Singapore dollars on the Marketnode platform. The platform ensures a seamless workflow through smart contracts. Additionally, OCBC Bank, in partnership with the digital exchange MetaVerse Green Exchange, developed green financial products based on tokenized carbon credits.
Examples of alternative uses of digital assets are quite limited. However, the spread of CBDCs, unfortunately, continues unabated and receives top priority among central bank executives.
Why central banks shouldn't rely entirely on CBDCs
The legalization and implementation of decentralized digital currencies (not CBDCs) would intensify competition among financial institutions, which would be beneficial for everyone involved. Broadening the variety of investment digital assets, which would compete with traditional financial instruments, could attract new customers. This could spur increased competition and the adoption of blockchain innovations in the financial industry, as well as expand the user base. A notable example is the Australian bank NAB, which introduced its own stablecoin when it grew tired of waiting for the implementation of the state CBDC from the country's central bank (RBA).
It's crucial to understand that the implementation of a national CBDC could disrupt the traditional financial rules and norms and pose risks to the financial stability of the entire banking system. Thus, regulators and financial institutions should carefully examine the potential risks associated with CBDCs and possibly reevaluate their strategies for integrating them into traditional financial services. Or they may even consider abstaining from their implementation altogether!
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