Digital Dollars: Central Banks and Cryptocurrency

As the world races towards a digital economy, the Bahamas took the lead in being the first country to launch a nationwide Central Bank Digital Currency (CBDC) referred to as the “Sand Dollar”. A CBDC is a digital form of currency issued and regulated by the Central Bank of given country, and therefore recognized nationally as a legal form of money acceptable as payment for any monetary debt or expense. This type of currency was inspired by bitcoin, the first cryptocurrency to be officially launched. Bitcoin is known for its use of blockchain technology which is said to be virtually immune from fraudulent transactions and data breach. Blockchain technology is also touted for eliminating the need for banks, centralization, and thereby lowering transaction costs. However, CBDC’s unlike Bitcoin, marries the convenience and security offered by cryptocurrency and the regulation and subsequent stability offered by the Central Bank. 

According to the Bank for International Settlements, 80% of central banks around the world (including Jamaica) are exploring the possibility of implementing CBDC. The Bank of Jamaica’s (BOJ) interest in offering a CBDC became clear in 2020 when it invited regulated entities and financial technology (fintech) companies in partnership with Deposit Taking Institutions to develop and test potential CBDC solutions in its Fintech Regulatory Sandbox. The Sandbox offers a medium through which innovative financial products, services and businesses may be tested in a live, yet controlled market environment. This is being done with a view to promote competition and financial inclusion while mitigating the risks to financial stability. 

The BOJ’s expediency in experimenting with the idea of digital currencies may be viewed as a direct response to the rapid rate at which innovative financial technologies are being developed, the popularization of decentralized cryptocurrencies, the declining use of cash, and the prevalence of debit and credit card fraud.

Advantages of CBDC

With the prevalence of debit and credit card fraud and the declining use of cash, a CBDC may be the way forward for Jamaica. It may offer a solution to issues of security and trust that have plagued the finance industry for years, as it is designed to detect and prevent forged transactions from being successfully approved and make it very difficult for the currency to be stolen.

According to the World Bank Global Financial Development Report, 29% of Jamaicans over the age of 14 do not have a bank account, and one of the primary reasons for this is lack of trust. The Covid-19 pandemic has made apparent and immediate the need for financial inclusion and accessibility to financial services. As the Government of Jamaica rolled out its financial assistance programs to cushion the effects of the pandemic on individuals who were laid off, many individuals faced difficulty claiming the grants because they did not have a bank account. 

The introduction of a CBDC may allow for greater financial inclusion as it may not require a bank account if the BOJ decides to offer it on a retail basis (that is, directly to consumers). However, even if the BOJ does not decide to offer the currency directly to citizens, the level of security offered may make it more enticing to the unbanked who use the currency through deposit taking institutions.

Other advantages of CBDC may include 24/7 settlement hours, faster transaction processing times and real time settlement, especially if reliance is no longer placed on banks and other intermediaries. Also, given the high cost of producing, storing, transporting, disposing, and managing cash, a CBDC may account for significantly lower transaction fees as it would avoid all those costs. 

Disadvantages

Although one of the key motivating factors for the introduction of CBDCs is the benefit of financial inclusion, if this results in the premature abolition of cash, further financial exclusion may result. Vulnerable groups such as the elderly, poor, and individuals who live in rural areas who have limited or no access to internet service and mobile devices, would be disadvantaged. However, in addressing any such concerns that may arise, the BOJ has made it clear that its intention is not to abolish cash as they will continue to issue bank notes and coins to facilitate all economic activities.

Another disadvantage may be the cost associated with developing and maintaining the system required to launch the digital currency. Also, an observation which was made by the IMF was that failure to satisfy any of the functions related to the a CBDC due to technological glitches or even human error, could undermine the central bank’s reputation. 

What does this mean from a policy perspective?

As the BOJ progresses towards potentially launching a CBDC, there are a number of legal issues that need to be considered. Data privacy is critical for the implementation of a digital currency and as such data protection legislations will play an even more major role in the future of the finance industry. 

One of the key features of many digital currencies is the immutability of transactions (i.e., transactions cannot be modified, reversed or replaced); however, if this feature is utilized by the BOJ, the BOJ may need to address issues concerning the ‘right to be forgotten’, which is a core tenet of the General Data Protection Regulation (GDPR) law in the European Union (EU) and arguably a human right in a digital society. This right allows persons to demand that information about them be deleted. Legislators may therefore need to explore ways to strike a balance between rights of access to information and privacy while the BOJ continues to ensure stakeholders are compliant with applicable consumer protection and data privacy laws.

A CBDC will likely result in more rigorous KYC and AML processes to prevent the digital currency from being used for nefarious purposes, such as money laundering, tax evasion, fraud and other financial crimes.  The BOJ Sandbox is an excellent move to aid its understanding and test the positive hypotheses of Fintech products, services and business models. It will also inform the framing of new regulations or amendment of existing regulations.