Digital currency: emerging global financial architecture

Digital currencies (also known as cryptocurrencies e.g., Bitcoin) are currencies that use blockchain technology to record and secure every transaction. Digital currencies as the name suggests can be used in a digital form of cash to pay for everything from grocery items to household durables including buying homes.

A digital currency  can be bought using one of several digital wallets or trading platforms, then digitally transferred to complete a  transaction involving a purchase or any other transactions with the blockchain recording the transaction and the new owner.

Blockchain is the digital platform behind all digital currencies. It is intended to create faster, more efficient ways to transmit, receive and track orders using secure data. Blockchain also referred to as Distributed Ledger Technology (DLT) makes any digital asset unalterable and transparent through the use of decentralisation and cryptographic hashing.

A Blockchain, as the term suggests, is a chain of blocks and operates across a vast network of computers. Making a change to any block in the chain requires reconfiguring not only the block with the change, but also all blocks that come after. This is why it is so extremely difficult  to manipulate blockchain technology. In fact, blockchain enables the existence of digital currencies.

According to MIT Technology Review, "The whole point of using a blockchain is to let people - in particular, people who don't trust one another - share valuable data in a secure, tamperproof way". In summary, a blockchain is a database that stores encrypted blocks of data then chains them together to form a chronological single source-of-truth for the data.

Blockchain makes digital currency theft much harder as each currency has its own irrefutably identifiable number that is attached to one owner. A transparent ledger of changes preserves the integrity of the document, which creates trust in the assets. More importantly, a digital currency reduces the need for individualised currencies and central banks. With blockchain, the currency can be sent anywhere and anyone in the world without the need for currency exchanging or interference from central banks.

The adoption of a digital currency such as bitcoin has the potential to decrease the risk of current and future governments, whether home or foreign governments, from imposing policies that might restrict the freedom of movement of capital, assets and restrict other financial transactions.

Technology innovation facilitates digital currencies. Blockchain is an especially promising technology and it helps reduce risks, eliminates fraud and brings in transparency in its all uses. Blockchain also enables transactions without a central authority i.e., a central bank which presents advantages that have been hailed as the key to the growth in international trade.

A digital currency enables its owner to be the custodian of one's own assets without any intermediaries. Therefore, that comes with some personal responsibilities as there are no central authority like a central bank that can help if one lowers one's guard. Security, vigilance and a good dose of scepticism will help to deal in a digital currency. Also,  as and when dealing in with any financial product, one must stick to the dictum "if it seems too good to be true, it usually is".

There are many legitimate concerns about blockchain based digital currencies such as lack of regulation or any codified laws in dealing with these currencies. Digital currencies have shown a high degree of volatility due to aforementioned reasons which enabled  speculators to enter the market to make speculative gains. 

But in the process speculators have further added to  market volatility e.g., bitcoin price per token has fluctuated between US$450 and US$60,000 since 2016. Lack of stability has led to some winners and  losers. Despite all those concerns many large corporations such as Tesla invested in bitcoin and accepts it as payment for their cars.

The spread and volatility of digital currencies including the technology involved in it has attracted the attention of many financial experts. Digital currencies also challenge the definition of money as we understand now by switching from public fiat  to private electronic money. They have also created  powerful decentralised payment systems which among others also help to overcome some economic development limitations.

Digital currencies could boost economic growth in developing countries because they have the potential to address many practical constraints faced by these countries on the delivery of financial services. It is estimated that half of the adults in developing countries do not have a bank account. Digital currencies could substantially reduce transaction costs and allow increased economic activity, thus stimulating economic growth.

Many developing countries heavily rely on remittances. Existing remittance services charge fees for these transfers that can make up a significant proportion of the maney sent, particularly for smaller transfers. Furthermore, many people do not have bank account that requires in-person collection of money further adding to the transaction costs. Now one of the uses of digital currencies tends to be a substitute for bank accounts but that requires access to internet.

It has been observed that the usage of the internet in developing countries has increased dramatically over the past decade and continues to grow rapidly, thus reducing the cross-border payment costs using digital currencies. Digital currencies, therefore, could help to increase financial inclusion in developing countries by serving as a quasi-bank account, since anyone with internet access can download a bitcoin wallet.

These currencies are not only very promising for remittance payments but also for participation in international trade without having a bank account. The decrease in transaction costs could also increase the possibility for microcredits because currently fiat money based transactions face high costs.

The increased financial inclusion is the most significant benefit of digital currencies for the people in developing countries. As already pointed out digital currencies not only lower transaction time and costs but also can act as a type of bank account to enable to undertake all banking type transactions.

El Salvador passed a bill  in June last year that would see bitcoin become legal tender in the country alongside the US dollar, the country's national currency. This marks the first time bitcoin being adopted as a legal tender in a country.

While a developing country like EL Salvador is opening up the opportunities that bitcoin can bring, now central banks have also embarked  on explanatory projects on issuing Central Bank Digital Currencies (CBDCs). A CBDC uses an electronic record or digital token to represent the virtual form of a fiat currency. A CBDC is a direct claim on the central bank and it is issued and regulated by the central bank, therefore it would have the same status as that of a traditional fiat money

G20 countries are at the forefront of undertaking these projects. A Bank for International Settlements (BIS) (which serves as a bank for central banks) survey of central banks found that 86 per cent are actively researching the potential for CBDCs, 60 per cent were experimenting with the technology and 14 per cent deploying pilot projects.

But widespread use of CBDCs does not appear to be imminent as central banks are working out the effects of a CBDC on interest rates, price stability, financial security and above all safeguarding public trust in money  along with an assessment of its impact on the banking system as a whole. But it definitely will come, just a question of when.

According to the BIS, a central bank digital currency (CBDC) would be a digital banknote. It could be used by individuals to pay businesses, shops or each other (a "retail CBDC"), or between financial institutions to settle trades in financial markets (a "wholesale CBDC").

The BIS further adds, "if successful, CBDCs could ensure that as economies go digital, the general public would retain access to the safest form of money -- a claim on a central bank. This could promote diversity in payments, make cross-border payments faster and cheaper, increase financial inclusion and possibly facilitate fiscal transfers in times of economic crisis (such as a pandemic)".

So far, the unique status of the US dollar in the global financial system enables the US to exercise its power extraterritorially without resorting to military intervention using economic sanctions. In fact, the US has weaponised the dollar to achieve its global strategic objectives.

Now CBDCs offer opportunities for the US sanctioned countries like Iran, Venezuela and Syria to Cuba, North Korea and Russia to operate outside the US dollar-dominated global financial system with no regard for sanctions.

The widespread use of CBDCs, in particular China's digital yuan which is in an advanced stage of development could offer the US-sanctioned countries  an alternative to the US dollar for global trade. A digital yuan may also expedite internationalisation of within the Belt and Road Initiative (BRI).

An internationalised digital yuan would drastically affect global finance and political-economic governance with transformative implications. Also, China is the world's largest exporting country and the digital yuan can make buying from or selling to China easier and cheaper and allow to  bypass the bank based global system to make and receive payments.

More importantly, countries around the world may start considering a basket of currencies including CBDCs like digital yuan as the new world reserve currency, that could cause the US dollar lose its preeminence as the world's  reserve currency.

With the emergence CBDCs such as  digital yuan as a potential global reserve currency, we are now in for a very exciting time heralding a new era of the evolution of digital currency.  It now appears that the stage is set for the global monetary system to undergo the most significant changes since the Bretton Woods agreement that led to the US dollar becoming the dominant global reserve currency. The global financial architecture will unlikely to be the same as it is now.

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