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The development of a central bank digital currency could deprive banks of much of the control they have today

This article was first published in FinansWatch.

PA Consulting’s Thomas Bjørnstad, financial services expert, is quoted in an article discussing a digital central bank currency.

In the wake of the strong interest in cryptocurrency, it is time to look ahead and consider if central banks will start issuing digital money before there is an imbalance in the system?

If the use of a cryptocurrency or private payment solutions becomes too great, the state and the central bank could lose control of the monetary system and they will never want to find themselves in that position.

In response, tighter regulation is now on the cards in Europe and will include rules on market manipulation and insider trading as well as new rules and fees for issuers and service providers. Norges Bank is currently investigating the alternative of issuing digital central bank money (DSP).

Already launched in China

PA Consulting recently mapped the status and possible implications of digital central bank money for a European authority in an unpublished report. The use of a DSP could have major consequences for all the world's banks with implications which go well beyond financial issues.

Thomas Bjørnstad partner in PA Consulting told FinansWatch, that “China, which was the pioneer of issuing banknotes, is the first major economy to launch a DSP through its digital renminbi initiative, and this is currently being tested by over 100 million users. According to the Chinese authorities, the motive for this is mainly the fight against corruption, where DSP provides traceable and transparent transactions.”

Others, however, point out that a digital currency may be a cheaper and more convenient alternative to international transactions outside the US sphere of influence in the global financial system. Equally, if large countries such as the USA and China issue DSPs this may mean more countries will choose to create their own DSPs.

The central bank is on the pitch

Norges Bank will soon recommend whether the central bank should continue working on specific technical testing of a DSP solution. This will have major implications for Norwegian banks, with a digital currency opening up a number of opportunities.

“For the commercial banks in Norway, a DSP will be of fundamental importance for their systems, processes and infrastructure. Norway’s banks have so far to a large extent been responsible for and owned important parts of the infrastructure and its management, including the infrastructure for real-time settlement, albeit closely integrated with Norges Bank. With the introduction of a digital currency, supported by the central bank, there may be fundamental changes in the assessment of the structure of these when looking ahead in time and which infrastructure solutions and partners to invest in,” says Bjørnstad.

He underlines that exactly what it will look like depends on how the DSP is designed.  Will it be account-based or token-based? Will it only be distributed by the central bank, or by banks and other intermediaries? A hybrid model is considered the most realistic, as the central banks themselves lack, and probably do not want to take on, a role related to customer and account management. The central banks also do not want to have any responsibility for either AML / CTF or KYC.

“Another question is which underlying technology is chosen. While many of the major existing digital currencies such as Bitcoin, Ethereum and Facebook's Diem are based on blockchain technology, China has chosen not to use this technology and has opted for a token-based DSP instead. Norges Bank was also sceptical of decentralised technology in the past, but has since changed its view. Sweden, which, like Norway, has low use of cash, is working on a pilot with e-krona based on decentralised blockchain technology,” says Bjørnstad.

Several countries have dropped out of DSP

It is possible that Norges Bank will choose to abandon a  DSP completely and cease work on it. The Danish central bank has already done this concluding, in 2017, that the advantages did not outweigh the disadvantages. Equally, the Ecuadorian central bank's digital currency was ended due to low prevalence and low transaction volumes.

“A possible introduction of DSP will have major consequences. If the work in Norway continues, and we are still waiting for a response from Norges Bank. It is too early to say exactly when and if so how an introduction will take place if the bank chooses to proceed, but we will probably be well into the 2020s before it happens. While the global work on digital central bank currency has intensified, the concept is so new and immature that we must expect to see a longer period of designing solutions and iterative testing before we approach full implementation,” says the PA partner.

Private players lead the way

As there will also be a need for close international coordination and probably regulation, PA would be  surprised if Norges Bank chooses to take an aggressive leadership position in the development, but the bank will want to follow the leading players and not fall far behind. At the same time, shutting down the work now, as Denmark has apparently done, seems a very passive response. A further period of experimentation combined with close international cooperation to see how things play out in other countries and learn from that makes sense.

Bjørnstad summarised the position saying, “While central banks and the authorities analyse and think carefully in order to consider all societal implications in a comprehensive solution, private actors continue the development and launch of innovative payment solutions, including crypto-based solutions at breakneck speed. Customer and user needs are at the centre, and central banks will never be able to beat them on the speed of innovation. At the same time, there are societal considerations that these players will not necessarily have incentives to deal with. In these cases, the authorities will be able to play the regulatory trump card. We are now seeing this, for example, through the EU's proposal to regulate cryptocurrencies to reduce risk to investors and to financial stability.”

Contact the financial services team


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