Did Cryptocurrency Force Central Banks to Create Their Own Digital Currency? Is There a Race Between China and The US To Launch CBDC First?

As per Carl Menger  “Money is not an invention of the state. It is not a product of the legislative state”. We did not require the government to originate money, it has emerged over the years, then why do we need them to guard our money. With the rise of decentralisation and immense development in technology, people have started to believe that they may be able to reduce banks’ role. 

The numerous bank runs and financial disasters have made people lean towards decentralised currency (Cryptocurrency) and they do not want to give banks control over their money. 

Cryptocurrency is hyped for various reasons like, people feel safe as they have control over the money, they can initiate faster cross-border transactions with lower fees compared to banks, it has a public ledger so everyone can see what everyone is doing, no fear of double spending and losing transaction information.

The reasons that make cryptocurrency exciting also makes it scary, it is decentralised so there is no one overseeing it which leads to a rise in hacks like Coincheck where $550 million and Bithub where $30 million were stolen by hackers. 

One of the major weaknesses is the high electricity cost of mining. Dolader Retamal pointed out “In 2014, the mining of Bitcoin consumed as much electrical energy as Ireland”. 

Other issues include Tax evasion, anonymity issues, hackers stealing private keys of people and using hacking techniques to enter into their wallets. Also, Bitcoin’s high volatility can make an investor lose all its money in one day and leave it unrecovered. 

Even with these risks involved people are still investing in cryptocurrency and this is what gives banks shivers that digital currency may replace traditional banking, which is why they are developing their own Central Bank Digital Currency (CBDC). Governments are challenged to determine the equilibrium between encouraging innovation and ensuring security. 

The accelerating growth of cryptocurrency and followed by Libra a private digital payment token launched by Facebook has forced central banks to create their own digital currency (CBDC) since it was challenging the central bank’s supremacy. 

What is CBDC?

Central bank digital currency is exactly as the name states it’s a digital currency of central bank pinned to a fiat currency that could be used as legal tender(medium of exchange). It may make it possible for people to hold bank accounts directly with Central Bank. They are the central bank's direct liability and are token-based. The main goal is financial inclusion and reducing the risk by being an alternative to cryptocurrency. 

Cryptocurrency VS CBDC

At first, Central banks were closely following cryptocurrency and were not taking any action but a survey of BIS (Bank of International Settlement) released in 2020 stated that 80% of the central banks are now exploring to supply CBDC to the public but only 10% have succeeded to develop pilot experiments. 

China has been a leading country indicating the serious intention of launching CBDC. In 2014 the People’s Bank of China (PBOC) created a committed group to focus on digital currencies and since then they have continuously intensified their investigation and pilot tests. China's CBDC project is called Digital Currency Electronic Payment (DCEP). 

The DCEP’s objective is to attain goals like meeting the retail payment needs of organizations, developing the internal systems of financial organizations and is predicted to replace SWIFT. 

In April 2020, One of the crucial steps of the PBOC was announcing a group of experiments to be carried out in 4 major cities of China. Enterprises like Walmart, Starbucks and many others participated in these pilot tests. The pilot tests are continuously carried out by new rounds of trials (in December 2020). 

On the other hand, the US, like the PBOC, has closely monitored blockchain and digital currency but has always questioned the commencement of CBDC as they do not support this proposal due to the danger that CBDC would impose on its monetary policy and financial stability. 

China has consistently believed in the benefits of CBDC and working towards introducing it whereas, the US is more cautious and had no intention of changing its existing legacy that is not worth the risk. 

This does not imply that the United States is unaware of the ramifications of CBDC and is falling behind. It understands the desire of other nations to establish CBDC, and few will be faster than others due to domestic and currency considerations. And US Fed stated that they would not be among the first countries to do so.

Mr Powell stated, "We do think it is more important to get it right than to be the first,". 

Watchers are drawn to portray most US-China disputes in terms of a "race," but this is not always relevant in the CBDC framework. We call it a race only when there is some agreement on where the finish line should be, which in this situation would entail agreement among watchers and central banks that it is ideal to establish CBDC. However, just 30% of the central banks polled by the BIS said that they intend to issue a CBDC within the following six years, implying that no such agreement resides.

Here we are to the end of my blog series, in which I explained my research on cryptocurrency based on technology, safety, hedge, diversifier, and threats to the central banks, and the outcomes are: cryptos are secure but not completely and require constant regulation, and that bitcoin has the largest market cap. And presently, bitcoin is not a hedge due to its high volatility and lack of a long history like gold, subsequently, I demonstrated that we may presumably increase our overall returns by combining bitcoin with traditional assets in our portfolio. Finally, cryptocurrencies posed a danger to central banks, prompting them to form CBDC. And there is no rivalry between China and the United States; it being that the United States is extremely vigilant and does not want to cause any complications.

I hope you enjoyed exploring the world of cryptocurrencies with me.

Thanks a lot!

References : 

Note - Table was created by me.

Ostroff, C., 2020, ‘Why Central Banks Want to Create Their Own Digital Currencies Like Bitcoin’, MarketScreener, URL: https://www.marketscreener.com/news/latest/Why-Central-Banks-Want-to-Create-Their-Own-Digital-Currencies-Like-Bitcoin--31583754/ 

Lee, D., Yan, L., and Wang, Y., 2021, ’A global perspective on central bank digital currency, URL: https://www.tandfonline.com/doi/pdf/10.1080/17538963.2020.1870279?needAccess=true 

Chorzempa, M., 2021, ‘China, the United States, and central bank digital currencies: how important is it to be first?’, URL: https://www.tandfonline.com/doi/full/10.1080/17538963.2020.1870278?scroll=top&needAccess=true

Novruzlu, A., 2020, ‘WHY CRYPTOCURRENCIES SCARE BANKS AND GOVERNMENTS?’, pages – 114 to 118, URL: https://www.researchgate.net/profile/Mushfig-Guliyev/publication/351023768_Book_of_Proceedings_esdBaku2020_Vol2_Online/links/60800638881fa114b416f8b4/Book-of-Proceedings-esdBaku2020-Vol2-Online.pdf#page=113 

Chaudary, V., 2019, ‘Facebook Libra pushing nations towards Central Bank Digital Currencies’, Coinnounce, URL: https://coinnounce.com/facebook-libra-pushing-nations-towards-central-bank-digital-currencies/

Singh, B., ‘CBDC Vs Cryptocurrency: Major Difference 4 Gov. Accept’, URL: https://www.wjsnews.com/cbdc-vs-cryptocurrency/