Digital Currencies: Their Types and Recent Developments in CBDCs
By Eolenka on ALTCOIN MAGAZINE
As a result of the exciting developments behind blockchain technology and cryptocurrencies, novel vocabulary has emerged to describe the new trends in digitalization of what we have traditionally understood as money. Numerous terms are used to refer to similar yet different concepts, often neglecting the nuances among them: digital currency, virtual currency, cryptocurrency, stablecoin, digital fiat currency, digital money, etc.
The below is an attempt to briefly summarize some of the widely-used non-legal terms in the sphere of digital currencies and make some sense of them. Due to many countries currently discussing the possibility of issuing their own national digital currencies, the focus is on stablecoins, and in particular the Central Bank Digital Currencies (CBDC), and the recent developments in the creating CBDCs around the world.
Digital currency is a currency that is held electronically, i.e. not in a physical form, and can take one of the following forms:
Cryptocurrencies
“Cryptos”, such as bitcoin, are a type of digital currencies that have real-world value, as their holder can use them to purchase real goods and services. They are decentralized (and are thus also referred to as peer-to-peer currencies), as their units are created and handled without any centralized supervisory body such as a central bank.
The European Parliament’s Special Committee on Financial Crimes, Tax Evasion and Tax Avoidance, in its report on Cryptocurrencies and blockchain: Legal context and implications for financial crime, money laundering and tax evasion, defines cryptocurrency as “a digital representation of value that (i) is intended to constitute a peer-to-peer (P2P) alternative to government-issued legal tender, (ii) is used as a general-purpose medium of exchange (independent of any central bank), (iii) is secured by a mechanism known as cryptography, and (iv) can be converted into legal tender and vice versa”.
Some cryptos are referred to as non-traditional cryptocurrencies. XRP of Ripple, for example, is a token used as a bridge currency to digitalize regular national currencies and cryptocurrencies transactions. It runs on Ripple’s digital payment network and protocol for financial transactions.
Second-generation cryptocurrencies such as Etherum or IOTA are platforms for decentralized applications and they can be considered more of payment processing services than actual digital currencies.
Stablecoins
Stablecoins are essentially digital currencies backed by an underlying asset or a basket of assets. According to the G7 working group on stablecoins, the term stablecoin stems from the intention to “stabilize” the price of the coin by “linking its value to that of a pool of assets.”
They can be pegged to fiat (government-issued) currency reserve, a cryptocurrency, a mix of different assets or they may not be collateralized at all, but instead using some type of central-bank-like mechanism to retain a stable price (also referred to seignorage-style or not backed stablecoins).
Stablecoins can be issued by the central bank and backed by the government reserves in the form of government-issued money and other securities. Such types of currencies are also known as Central Bank Digital Currencies (CBDC) or digital fiat currencies as they represent the digital form of a country’s fiat currency. We can distinguish among wholesale CBDCs — when aimed to be used by the commercial banks and other financial institutions in the financial markets only — or general-purpose CBDC — when aimed to be used by the general public.
They can also be issued by a non-state entity yet backed (partially) by the traditional money. An example of the latter one would be Libra, which was described as a stable digital cryptocurrency backed by a reserve of assets, including “bank deposits and government securities in currencies from stable and reputable central banks.”
Virtual currencies
Virtual currencies such as FarmVille coins are used within a specific community such as a social network or gaming. They do not possess a real word value as their value only exists within the limits of the artificial virtual communities and real goods and services cannot be acquired for them. These currencies are essentially centralized, as their developers control them.
Electronic (or digital) money
Sometimes the term digital currency is also used to refer to the electronic representation of the fiat currency. Also referred to as electronic money, digital money or cashless payments, these are essentially credit transfers, cheques, direct debits, card payments and other electronic versions of the so-called book money.
Countries jumping on the CBDC bandwagon
Several or the world’s top economies, including the US, EU, and other countries have been actively looking into issuing their own Central Bank Digital Currencies or CBDCs. However, none of the countries have spurred more interest in the media and markets as China, which could be on track to issue a digital version of its yuan potentially as early 2020.
The People’s Republic of China
China has been progressively moving towards a cashless society, with most of its 1.4 billion citizens using various mobile payment apps such as Tencent’s WeChat and Alibaba’s Alipay to pay electronically.
Aside from its numerous blockchain-related initiatives on the government as well private corporate level, after five years of research and development, China is reportedly almost ready to issue its own digital currency as early as next year. The People’s Bank of China (PBoC), the country’s central bank, has confirmed it was testing a digital version of the national currency renminbi, also referred to as the Chinese yuan. The Chinese CBDC should first be issued to commercial banks and other institutions, which will then resend it to the general public.
The main motivation behind the digital yuan is to protect and strengthen China’s monetary sovereignty and increase its influence in the global financial system. The following are some of the features of the digital yuan emphasized by the Chinese officials:
- Controllable anonymity: guaranteeing the anonymity of the payments as long as the user “doesn’t commit a crime” (no details on what this could mean in practice).
- Instant processing: enabling faster transactions, especially in cross-border sector.
- Volatility-free stable valuations: being a digital version of the government-issued yuan, the CBDC’s value is guaranteed by the PBoC.
- Closer oversight: giving the Chinese regulators more means of tracking the money flows, especially in the fast-growing e-commerce market and agriculture, making it easier to spot counterfeits and track the product’s origins.
Despite numerous benefits, it will be interesting to follow how China tackles regulatory obstacles with respect to its digital fiat currency. The challenges will arise in the spheres of anti-money laundering, data privacy, tax compliance, cybersecurity, and other policy areas, which may have to be reconsidered and adapted to encompass the CBDC.
The European Union
A draft EU document suggests that “the European Central Bank (ECB) and other EU central banks could usefully explore the opportunities as well as challenges of issuing central bank digital currencies including by considering concrete steps to this effect.”
Some believe that a digital euro based on bank deposits created and issued by the ECB would be necessary to “save” the EU monetary union. The German banks have also been pressuring the EU to consider innovating its payment infrastructure and issuing a digital euro so that Europe can “keep up with this competition so that the global financial architecture does not lead to a polarisation between American or Chinese solutions.”
Other countries
The United States’ central bank Federal Reserve (Fed) has been reportedly also looking into developing a digital dollar, while carefully pondering the risks associated with such a move. Philadelphia Federal Reserve Bank president Patrick Harker deems it “necessary”, although he thinks the US should not be “the first mover as a nation to do this.” However, not everybody shares the same enthusiasm about issuing a digital dollar, with the ex Fed Chairman Alan Greenspan saying there is “no point in doing it”.
BRICS (Brazil, Russia, India, China, and South Africa) has proposed issuing a digital currency for payment settling among the member countries, aiming at additionally decreasing the share of the US dollar in foreign trade settlements.
Hong Kong and Thailand have been cooperating on various fintech projects since May, including the possibility of issuing a CBDC. However, if issued, such currency will be used only for domestic interbank payments, corporate payments and securities settlement rather than also as a retail currency.
Turkey is planning to conduct the first trial of its digital lira by the end of 2020 to strengthen its position as a “global financial player”.
The list goes on, with countries like Canada, United Kingdom, Uruguay, Sweden, and Venezuela, among others, have had to also some degree already investigated the viability of introducing a central bank-issued digital currency.
