When Facebook backed the Libra cryptocurrency in 2019, governments around the world took notice. Libra still hasn’t launched, but the Facebook cryptocurrency and China’s digital Yuan pilot are prompting governments around the world to more seriously consider digital sovereign currencies.
What is a digital sovereign currency? It’s basically a digital version of a sovereign currency, or the bank notes that central banks like the Reserve Bank of Australia issue.
But cryptocurrencies like Bitcoin and more recently, the Facebook-backed Libra coin are raising questions about the role of sovereign currency in a world that’s increasingly becoming cashless.
Bitcoin, the first cryptocurrency to put blockchain or distributed ledgers on the map, relies on decentralised technology was designed to disrupt the traditional banking model, which requires banks to validate transactions.
Since launching in 2009, Bitcoin hasn’t reshaped the banking system due to its price volatility, which also makes it a problematic replacement for cash. But it’s also spawned numerous other cryptocurrencies like Monero, and distributed ledger technology (DLT), such as Ethereum, to record and verify transactions.
The Facebook-backed Libra cryptocurrency project is known as a stablecoin – a less volatile cryptocurrency because it’s pegged to a commodity, currency or a set of currencies.
The emergence of Libra – currently only described in a whitepaper – has forced some central banks, including the Reserve Bank of Australia (RBA), to explore a central bank digital currency (CBDC), or digital sovereign currency.
Central banks are now rushing out digital sovereign currency pilots partly in response to Libra, but also China’s central bank-backed digital yuan, says Dr Anton Didenko, a lawyer who worked at commercial banks in Russia and is currently a research fellow at the University of New South Wales.
“We look at Bitcoin and cryptocurrencies. There were currencies that didn’t mean or do much, but then Libra was announced last year, and it gave governments a push to work towards sovereign digital currencies,” Dr Didenko told InnovationAus.
China wrapped up its largest central bank digital currency pilot to date last month, putting it further ahead of other central bank digital sovereign currency efforts.
China’s digital yuan aims to replace cash transactions for purchasing goods and services rather than replacing deposits in banks – a key source of funding for banks.
China’s central bank, the People’s Bank of China, earlier this month said its sovereign digital currency had been used in over 4 million transactions totalling 2 billion yuan or US$300m.
Sweden’s central bank, Riksbank, in February launched a trial of the e-krona. Both nations and others are increasingly seeing cashless societies emerge. The Riksbank wanted to see if an e-krona could address problems in a cashless society and to explore what role it and the government will play in tomorrow’s payments market.
Facebook is the most important member of The Libra Association, the Switzerland based non-profit administering Libra. But Libra has faced challenges from regulators and lawmakers. Until October 2019, the association’s members included Visa, Mastercard, Stripe, and PayPal.
In June 2019, the association released the first Libra whitepaper, describing the currency, its potential for cross-border transfers, and the instruments that would make it a more stable cryptocurrency than Bitcoin and other cryptocurrencies.
China’s central bank was nervous about the implications of Libra. A month after the Libra whitepaper was released, the director of the People’s Bank of China research bureau Wang Xin aired concerns about Libra being tied heavily to the US dollar and warned that if so, “it would bring a series of economic, financial and even international political consequences.”
Libra could also create difficulties for Chinese cross-border payments, monetary policy and financial sovereignty.
Last October US Senators wrote to Visa, Mastercard and Stripe with concerns over how Facebook would prevent Libra being used for criminal and terrorist financing, as well as destabilising the global financial system. A week later the three payments firms pulled out. PayPal had withdrawn a week earlier.
But as Dr Didenko points out, several developing economies had already ventured into sovereign digital currency projects in the past five years. It’s just that they didn’t really take hold.
Ecuador in 2015 launched its USD-pegged central-bank operated electronic money platform. Venezuela created the petro (₽) in 2018, but it faced troubles due to hyperinflation. And in 2018, the Marshall Islands, a nation that used the US dollar for decades, created the Marshallese sovereign (SOV).
“It didn’t go anywhere and that’s it,” says Dr Didenko.
The RBA this month announced a partnership CommBank and NAB to “explore the potential use and implications of a wholesale form of” CBDC using an Ethereum-based digital ledger. That is, for things like purchases of financial assets or large-value payments in wholesale banking markets. Sweden’s pilot focused on retail CDBC.
An RBA study released in September highlighted several risks of a retail CBDC. Consumers might “in the extreme” not only switch to CBDC over cash but also turn to RBA-backed CBDC instead of deposits in commercial banks.
But Dr Didenko argues there is a potential optimal case for a sovereign digital currency. That could be, say, a Pacific nation that has just one commercial bank.
A CBDC could allow the central bank to broaden payment options for the population rather than only serving the country’s largest banks.
“It would give the central bank new tools to offer its own liabilities to the general population,” says Dr Didenko.
Physical bank notes are a liability of a central bank, but deposits in banks – which can already be transferred electronically – are a commercial bank’s liability.
“Now you can have a single computer system that the central bank could run. You don’t need a dozen banks to do that – and you could have a central bank offer central bank accounts.”
“The most promising cases involve a combination of a central bank and the commercial banks because this really impacts competition. A central bank digital currency will not just compete with the banks, it will likely compete with payment platforms,” says Dr Didenko.
“But the extent of such competition will depend on the design of the new sovereign digital currencies: the options are many.”