… but what does that really mean?
The Governor of the Bank of Ghana, Dr. Ernest Addison recently disclosed at a press conference that the Central Bank is in advanced stages of introducing a digital currency called the E-Cedi. Dr. Addison said cryptocurrencies such as Bitcoin are too volatile to play the function of money hence the need for a state-backed digital currency such as the e-cedi to facilitate transactions within the economy.
Currently, more than 70 countries around the world are conducting Central Bank Digital Currency (CBDC) initiatives. In April 2020, China became the first major economy to pilot a digital currency. The People’s Bank of China is aiming for increased domestic use of the digital yuan by the 2022 Winter Olympics in Beijing.
The E-Cedi will essentially be the digital version of the Ghana Cedi; but what does that really mean?
What is a Central Bank Digital Currency (CBDC)?
A Central Bank Digital Currency (CBDC), or national digital currency, is simply the digital form of a country’s fiat currency. Instead of printing paper notes and minting coins, the Central Bank issues electronic tokens, whose value is backed by the full faith and credit of the government. The supply of the CBDC will be fully controlled and determined by the Central Bank.
The Bank for International Settlements (BIS) describes a CBDC as a digital form of Central Bank money that is different from balances in traditional reserve or settlement accounts held with the Central Bank.
Is a CBDC a type of Cryptocurrency?
A cryptocurrency is a digital or virtual currency that uses cryptography which is the science of transforming information into a protected format for security and anti-counterfeiting measures. Cryptocurrencies are not issued by any central authority (Central Banks) like fiat currency and there are currently over 2,000 different types of cryptocurrencies for different uses and purposes. All Cryptocurrencies or Tokens run either directly or indirectly on a Blockchain.
A Blockchain is simply a digitized, decentralized, public ledger of all cryptocurrency transactions. The list of records which are called blocks are linked using cryptography. The transactions are stored and distributed across many computers such that the record cannot be changed without altering all the subsequent records. Blockchain is based on Distributed Ledger Technology and has many different commercial applications today despite being originally developed for cryptocurrencies like Bitcoin.
Bitcoin, the most popular and widely traded cryptocurrency is a form of digital money that runs on a blockchain and is not backed by any country’s Central Bank or government. Bitcoin can be traded for goods or services with vendors who accept Bitcoin as a medium of exchange. Bitcoin was created by a software developer under the pseudonym Satoshi Nakamoto. Smaller units of Bitcoin are called Satoshis.
A Central Bank Digital Currency (CBDC) is not a type of cryptocurrency even if it runs on a blockchain. CBDCs are created by Central Banks, whereas cryptocurrencies are not issued by any central authority. CBDC transactions will likely still go through the banking system, whereas cryptocurrency remains largely peer-to-peer with no official financial intermediaries or middle men. CBDCs retain the same value as their respective paper notes and coins whiles the value cryptocurrencies tends to be very volatile.
Isn’t the cedi already digital? How different will the e-Cedi be from what is currently held in my bank account or MoMo wallet?
Even though the deposits in bank accounts and MoMo wallets are already digital and can be moved around electronically using credit and debit cards as well as mobile payments apps, this form of digital money is the primary liability of commercial banks. These banks keep and maintain actual balances to back up all the funds which are being pushed around. CBDCs on the other hand will be the direct liability of the Central Bank, which means that the Central Bank bears the primary obligation regarding transactions involving a CBDC.
Why do Central Banks want to introduce CBDCs?
It is obvious that the boom in cryptocurrencies over the past few years has pushed Central Banks around the world including Ghana to work on digital versions of their existing fiat currencies. Ghana has been forward looking in the quest to get ahead of this change in the traditional way money is used.
In February this year, the Bank of Ghana announced a regulatory Sandbox Pilot focused on areas like blockchain technology, remittance products, crowdfunding products and services and financial inclusion. The Central Bank is hence looking to be proactive about countering the growth of private forms of digital money.
In Ghana, digital payments have seen huge growth and usage numbers as evidenced by transactions on mobile money (a form of digital payment). Mobile money transaction value at end of April 2021 according to the May 2021 Summary of Macroeconomic and Financial data was GH¢83.8 billion compared to GH¢17.5 billion by cheques.
Governments have become increasingly interested in understanding how CBDCs can complement or replace cash in the last several years.
Today, many countries are moving towards a cashless society due to increasingly abundant and pervasive digital payment applications. The COVID-19 pandemic has underscored the need for and importance of digital payments. The government could have directly funded individual accounts with stimulus payments without the need for any intermediaries.
The Bank of International Settlements (BIS) carried out a survey of 66 Central Banks in the second half of 2019 and the 5 most common motivations for exploring a CBDC were found to be financial stability, payment safety and efficiency, monetary policy implementation and financial inclusion.
Financial Stability: Dr. Addison’s reference to Bitcoin and other Cryptocurrencies supports the point that the development around Central Bank Digital Currencies is largely a response to the soaring popularity around cryptocurrencies and the impact they have or may have in the future as they grow and become more integrated into any particular economy. The Bank of Ghana is looking to explore solutions before users adopt an alternative over which the government would have limited control in the quest to maintain financial stability within the economy.
Payment Safety and Efficiency: According to the Bank of International Settlements (BIS), the introduction of CBDCs can improve liquidity by allowing faster transaction speeds. The Bank of England has also noted that it can boost GDP by up to 3% by lowering transaction costs associated with transfers and transactions.
Financial Inclusion: As has been seen with digital money solutions like mobile money, national digital currencies are primarily being considered as a means to increase financial inclusion, by allowing governments to include unbanked populations in the digital economy.
Monetary policy implementation: The monetary policy transmission process may be strengthened by enhancing the pass-through of the policy rate to money and lending markets. Monetary policy implications are likely to be more apparent if the CBDC emerges as an attractive asset to hold. The level of interest paid if any on CBDCs would have a direct impact on demand for it.
What forms can CBDCs take?
There are two main models along which CBDCs will likely be built and deployed. They are, Retail CBDC or Wholesale CBDC. Central Banks that have been testing CBDC will look to implement either of these models or a mix of both.
Retail CBDC: Retail payments and transactions involve payments between individuals, or between individuals and businesses. This model of CBDC will be available to all participants within the economy. Retail CBDCs could be issued to the public through deposit accounts directly with the Central Bank or through digitally issued tokens which could be issued by the Central Bank for distribution by Commercial banks.
Wholesale CBDC: While a retail CBDC refers to a digital version of cash, a wholesale CBDC refers to a new infrastructure for interbank settlements. A wholesale CBDC model would enable the payment and settlement of transactions between financial institutions. According to the Bank of International Settlements, wholesale CBDCs can improve the development of capital markets, enhance cyber security and provide improvements in securities trading and settlement.
What are the benefits of CBDCs for end users?
- CBDCs can be a win for remittances. Ghanaians and Africans both at home and in the diaspora can send remittances within and across borders more cheaply. This has the potential to boost business and reduce counterparty risks. These transfers would also be in real time and around the clock as opposed to some current systems where international payments can often take some days to get processed.
- The burden of carrying physical notes and bills for transactions is further reduced and financial convenience is enhanced. From a user perspective, CBDCs are similar to other forms of mobile payment applications so for a Ghanaian user, the benefits are similar to using your mobile money wallet for mobile payments and transactions.
- The risk of loss or downtime arising out of financial intermediaries failing is significantly reduced. Whenever you use a mobile payment app, a credit card or any other type of digitalized money, there is risk that the financial institution providing the infrastructure may fail. Relying on the Central Bank rather than the financial institution would remove an intermediary and reduce the risk of loss arising out of the bankruptcy of your financial solution provider.
- The use of CBDCs will greatly increase flexibility in cross border payments. A simple scenario could look like this. A businessperson who needs to pay a supplier in China could buy US$1000 worth of the e-cedi, move it a digital exchange for eg. Coinbase or Bitnob, buy the digital Yuan and pay the supplier directly with the digital Yuan. The obligation to source for forex to back the transaction leaves the Ghanaian bank and now becomes the obligation of the digital exchange.
What are the risks?
- CBDCs are likely to raise issues about privacy as they could give governments the capability to monitor and scrutinize the financial activities of the general public. The advanced level of direct surveillance could be good to detect criminal activity but will be of concern for ordinary citizens.
- Commercial banks face an existential threat with regards to deposit mobilization if there is a massive shift from bank deposit to CBDCs. If the Central Bank pays some level of interest on CBDCs held by citizens thereby making it attractive to hold, it could give rise to higher uncertainty of commercial bank deposit funding as individuals would be interacting directly with the Central Bank. Also, in times of economic stress, there exists the potential for bank runs as individuals will move deposits to the safety of the Central Bank issued CBDC.
- The introduction of CBDCs without proper or adequate education will result in people being misled into fraudulent schemes and or being swindled by criminals. In Ghana, many people have fallen victim to mobile money fraud and if proper education is not provided, many may face the same fate with the introduction of CBDCs.
- If Central Banks choose a retail model for CBDCs they would need to radically build up and strengthen their operational capabilities to manage a digital currency, from managing deposits and reserves, to protecting user privacy, preventing digital counterfeiting and mitigating cyber-attacks and other operational risks. In periods of stress a flight towards the Central Bank may occur on a fast and large scale, challenging commercial banks and the Central Bank’s capacity and ability to manage such situations.
- Introducing a CBDC could result in a wider active and regular participation of the Central Bank in everyday activities. This means the Central Bank could, as a consequence, take on some of the traditional roles that have been borne by commercial banks like the allocation of economic resources. If the Central Bank falls short in efficiently executing this role than the private sector, it could result in economic losses.
The Bank of Ghana must be commended for taking early interest and action on exploring how digital currencies can be deployed within the Ghanaian economy. However, the process and phases being taken towards the launch of the e-cedi must be very carefully and thoroughly evaluated. The Central Bank must ensure that the possible effects on interest rates, exchange rates, asset prices and financial stability are exhaustively examined before such introduction.
>>>The writer is a licenced investment advisor and cryptocurrency enthusiast. He works with SAS Investment Management Limited. [email protected]