International cooperation and the era of digital currency growth

The COVID-19 pandemic and consequent economic crisis have indelibly altered our daily lives. One of the profound changes has been the acceleration in the shift towards digital payments, as customers avoided cash over fears it might spread the virus, and as retailers adapted by moving their activity online.

These challenges provided fertile grounds for exploring new digital forms of payment. How the world coordinates over the treatment of these new, potentially disruptive, technologies will critically shape whether the opportunities they present can be harnessed and the risks mitigated.

Two such new developments are central bank digital currencies (CBDC) and “stablecoins”. Central banks are actively looking at CBDCs, and demand for digital means of payments is here to stay. A Bank for International Settlements (BIS) survey found that more than 85% of central banks are exploring or researching CBDC, although in many cases their issuance is not yet concluded.

As examples, Singapore recently completed its Project Ubin, a multi-year investigation into the use of CBDC for wholesale transactions. China has been conducting advanced pilot projects for a digital yuan targeted at retail use. The European Central Bank and Bank of England each have active efforts researching CBDC. Beyond pilots, the Bahamas and the Eastern Caribbean Monetary Union have recently started to issue CBDC.

In contrast to CBDC, stablecoins are not issued by monetary authorities but rather private entities. They are generally conceived as a form of cryptocurrency, operating on distributed ledger technology but with stabilization mechanisms to keep their prices stable relative to an asset such as fiat currency, commodities or other cryptocurrencies. This means stablecoins do not suffer the same volatility as other digital currencies, thus making them a relatively stronger potential means of exchange and store of value. Some examples are Tether and USD Coin, which are pegged to the US dollar.

One of the main appeals of CBDC or stablecoins is the potential to enable faster or cheaper cross-border transactions, lowering costs to consumers, facilitating trade and strengthening global economic integration.

The pandemic has also highlighted the importance of improving access to digital financial services to effectively help those most in need. Digital currencies could potentially have been used to improve the distribution of aid and crisis relief payments particularly when travel or physical access was impossible. As an example, during 2020, the Grameen Foundation successfully disbursed COVID-19 financial support as digital vouchers to 3,500 women in the Philippines, used for groceries and medical packages, via an app on their mobile phones.

Another opportunity for both private and public digital currencies lies in fostering financial inclusion. Digital currencies could potentially lower the barriers that low-income and hard-to-reach populations face in accessing financial services. Several features could be designed, i.e. programmed, into the digital currency to ensure the integrity of the transactions. That said, further research into all three of the aforementioned opportunities is necessary, including consideration of risks and trade-offs and value-add capabilities versus pre-existing options.

These technological developments are not without significant challenges. The payment system is a public good; it needs to be regulated. For example, policymakers must address concerns about privately-issued digital currencies potentially being used outside of regulatory perimeters, facilitating money laundering or terrorist financing transactions. The ease by which digital currencies can be purchased and traded 24/7 over the internet and mobile phone, sometimes without the involvement of regulated entities, raises concerns about consumer protection, data privacy and potential cybersecurity risks.

On a macroeconomic level, CBDCs and stablecoins backed by major currencies could pose monetary and financial stability risks, especially to more vulnerable and developing economies. Some countries could suffer capital flight or exchange rate volatility arising from residents’ access to a CBDC issued by a major economy with strong economic fundamentals and low inflation (or access to a stablecoin denominated in a relatively stronger foreign currency). This, in turn, could disrupt bank lending and erase local liquidity from bank deposits.

To harness and contribute towards the global understanding and decision-making for these and other pressing policy and governance issues related to digital currencies, the World Economic Forum’s Digital Currency Governance Consortium has brought together more than 80 organizations to identify priorities and propose solutions. Since its creation in 2020, the work undertaken by the consortium has identified several key areas of focus.

First, international cooperation will be key to overcoming the challenges of cross-border digital currency flows.

There must be international consensus on the classification of digital currencies so that there can be consistent and effective cross-border regulation. The Financial Stability Board’s recommendations to address the regulatory challenges raised by global stablecoins could serve as a benchmark for individual jurisdictions. In addition, cooperation among regulators, such as through supervisory colleges, could reduce gaps and unevenness caused by the cross-border usage of these currencies.

Second, data privacy is paramount. Governments must establish appropriate practices for the sharing, owning or acquiring of account data to ensure the security of user data and the protection of privacy.

Third, public and private-sector collaboration is fundamental. The private sector can offer innovative products and services that support the authorities’ efforts to foster more resilient, inclusive and innovative payments. In turn, central banks and financial policymakers should take care not to crowd out private firms, but to design CBDCs or regulation in a way that spurs competition.

Lastly, technical interoperability should not be overlooked. The extent to which CBDC or stablecoin arrangements can connect with pre-existing and new systems domestically or cross-border will influence the value they provide to users and the benefits from enhanced market competition. However, interoperability may come at the expense of increased exposure to failures or breaches and a slower pace of innovation as providers conform to common data and software standards.

Rapidly and in the very near future, policymakers will have to make critical decisions about the role that public and private institutions will play in digital payments and digital currencies. They must also coordinate to resolve certain critical issues, arising from international spill-overs and within the cross-border payments space. These actions will determine the degree to which the world will be able to realize the benefits of digitalisation, which is perhaps a silver lining in the post-pandemic world.