MARKET VIEWPOINT

Will Digital Currencies Transform the Future of Monetary System?

Apr 7, 2021

As the financial services sector continuously undergoes digital evolution, so do the monetary platforms with adoption of new medium of exchanges like coins, banknotes, cheques, cards and digital currencies. During the COVID-19 crisis, measures to reduce cash transactions to mitigate virus transmission have further sped up the shift towards digital payments, hastening the decline of cash by four or five years i , while businesses with digital-only payment systems skyrocket to 31%. ii With economies transforming into cashless societies, central banks around the world are triggered to accelerate the development of Central Bank Digital Currencies (CBDCs).

The Digital Currency Revolution

CBDC is the digital form of a country’s fiat currency. Unlike private digital currencies, the CBDC is created and issued by, and a liability of, the monetary authority of the Government. There are two types of CBDCs:

• Wholesale CBDCs - designed strictly for financial institutions, in a form of central bank reserves and settlement accounts.
• Retail CBDCs - intended for transaction use by households and businesses, as a digital equivalent of cash. Depending on their design, they can upend existing financial system.

Today, 86% of central banks are exploring the benefits and drawbacks of a CBDC and about 60% of central banks, up from 42% in 2019, are conducting experiments or proofs-of-concept, while 14% are moving forward to development and pilot arrangements. iii In the future, CBDCs may displace cash and private cryptocurrencies, and may become the new norm.

Digital Currency Industry Implications

CBDCs can provide greater transparency and traceability that cut back the cost and friction which surround conventional forms of money transmission and alleviate the risks of offline paper money transactions, such as anonymous counterfeiting, money laundering, illegal financing and tax evasion. International remittances using digital currencies can also eliminate the need for costly intermediaries, allowing for lower fees and immediate settlement.

FinTech and financial services companies will play an important role in the distribution of CBDCs to end-users such as companies and individuals through their mobile payment networks. In mainland China, businesses have been required by law to accept its CBDCs - the Digital Currency Electronic Payments (DCEP) - as payment for purchases in all sectors. Thus, the banks are expected to increase the number of stores and services where digital currencies will be available with benefits of directing consumers to their own banking services. iv

Delivering the CBDC: Integration and Interoperability

Coordination among the public and private sectors, both domestically and internationally, will be increasingly required to address the gaps and opportunities in technological, governance and regulatory frameworks. With the rapid pace of digital currency innovation, the central banks would need to assess their Distributed Ledger Technology (DLT) readiness to better understand its potential application to digital currencies. DLT would play a critical role in CBDC functionality including security, scalability, and resiliency.

Furthermore, banks should prioritise enabling digital banking and payment systems to adopt new processing approaches by maintaining an IT infrastructure interoperable with CBDC systems. Financial services institutions will also be required to integrate and expand their infrastructure to user endpoints, including mobile wallets to perform seamless P2P and merchant payment transactions in both the legacy and CBDC environments. For merchants, they must also ensure that they have appropriate infrastructure in place to accommodate CBDCs.

Scaling Digital Technologies in Broadening Finance Activities

Central bankers and policymakers have started their digital currency designs to address challenges such as financial inclusion and payment system stability. For citizens and businesses, this will allow for instant payments and more efficient transactions, especially for cross-border settlements. Adopting digital technologies will drive CBDC at scale, provide greater resilience and create new opportunities to offer value-added services in broadening finance activities.