Condivergence: Digital currency comes of age

This article first appeared in Forum, The Edge Malaysia Weekly, on December 12, 2022 - December 18, 2022.
Condivergence: Digital currency comes of age
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The demise of FTX has set back public trust in cybercurrencies. Having been slow in clamping down on cryptocurrency scams, the central banks and financial regulators are beginning to realise that they must accelerate central bank digital currencies (CBDC) in order to ensure that cybercurrencies do not reach the scale at which they begin to eat into the central bank monetary creation franchise.

After years of trying to understand cybercurrencies, central banks have finally cottoned on that cryptocurrencies are neither currencies nor money in the strict sense, but are essentially tokens of exchange. First, they are not an asset that is backed by anything. Second, they are not issued by anyone, so they are not the liability of any legal person. Bitcoin is “mined”, namely created according to an algorithm that is supposedly uncrackable. You exchange value for Bitcoin, and its value goes up and down depending on the volume of buyers and sellers. Third, since there is no law backing it, there is no legal protection if you lose it or think you are being scammed.

The FTX debacle showed that exchanges may facilitate the transaction of different types of cybercurrency, but their liquidity is uneven, and available data shows that many of the transactions may be between related parties that could be treated as “related transactions” or market manipulation in regulated markets. For example, Bitcoin in dormant addresses accounted for more than 90% of the 19.12 million bitcoins currently in supply. In other words, the bulk of the transactions may be through a limited amount of users.

Thus, prices may be going up because of limited turnover, so more and more buyers are attracted. The real danger with cybercurrencies that attract many investors is that what goes up may come down. Value can only be sustained if there is underlying support for that value. If not, there are “Ponzi schemes”, which artificially support themselves by those committed to maintaining high prices by borrowing from Peter to pay Paul. Ponzi schemes usually end up with crashes and losses to those last in buying into the scheme.

The reason central bankers and regulators were hesitant to take action on such internet scams was for fear of “preventing innovation”. But as the negative systemic consequences became clearer from market experience, central bankers realised that they need to offer an alternative in the form of CBDC. Stablecoins, which offer some linkage to either a specific currency or commodity, are also not fully trustworthy because there is a question of custody or legal entitlement to the underlying asset. The value of stablecoins may not be stable if everyone tries to cash in for hard currency.

Nevertheless, there are three areas where cryptocurrencies will continue to add value, which is why they will not disappear completely. The first is payments, which may escape the detection of the official sector. Currently, wholesale and cross-border payments are heavily regulated for anti-money laundering, terrorist or criminal funding and sanction-breaking activities. However, central bankers and regulators have little idea what is transacted using cash. In that regard, instead of payments in cash, many small retail payments can be made using cybercurrencies without incurring the high transaction and reporting costs of going through official banking systems.

The second is the emergence of DeFi or decentralised finance, in which the payer and payee use blockchain technology distributed “flat” ledgers to transmit payments, which bypass the official sector altogether. DeFi can easily help or penetrate the informal sector, whereby those at the bottom half of society usually avoid taxation and official surveillance. DeFi may be extremely helpful to micro, small and medium enterprises (MSMEs) or social enterprises that wish to transact digital services both domestically and internationally more cheaply than the current usage of centralised finance (CeFi). CeFi is conventional banking that is highly centralised as all transactions are ultimately cleared at the central bank.

The third area is non-fungible tokens (NFTs). NFTs are certification of the authenticity or ownership of digital creative work that can be sold across the internet or DeFI using cybercurrencies. NFT trading for cybercurrencies then becomes an exchange of virtual wealth on a willing buyer, willing seller basis. Young creative people want to be able to trade their artistic creations for cybercurrencies and may not care that there is short-term volatility in their cybercurrencies, because the value of their NFT asset is also subject to the same volatility. NFT is a possible future market for digital services.

Central bankers are now offering CBDC as a serious alternative to digital assets. Currently, the Europeans are already at the consultation stage. The People’s Bank of China started very early and is already at the pilot stage of implementation domestically. In Asia, under the aegis of the Bank for International Settlements (BIS) Innovation Hub, Project Aurum is a collaboration with the Hong Kong Monetary Authority (HKMA) and the Hong Kong Applied Science and Technology Research Institute to look into two-level CBDC architecture and operations, namely, the wholesale level and the retail level.

Under the same BIS Innovation Hub, in October this year, the HKMA, Bank of Thailand, the Digital Currency Institute of the People’s Bank of China and the Central Bank of the United Arab Emirates published their report on the successful CBDC project for real-value cross-border payment and foreign exchange transactions, titled “Project mBridge: Connecting economies through CBDC”, on key results and lessons learnt from the pilot project.

At the next stage, there will be more experimentation with retail partners, such as banks, credit card companies and payment fintech start-ups to see how retail payments can be transacted, cleared, settled and effected using CBDC. In short, real-time digital business and payments using CBDC are coming on stream.

On Nov 14, ahead of the G20 Summit Meeting in Bali, Bank Indonesia, Bank Negara Malaysia, Bangko Sentral ng Pilipinas, the Monetary Authority of Singapore and Bank of Thailand signed a memorandum of understanding to strengthen and enhance cooperation on payment connectivity to support faster, cheaper, more transparent and more inclusive cross-border payments, using Regional Payment Connectivity (RPC). Using a standard QR code, it will be possible for retail payments to be made within the five countries quickly, efficiently, safely and securely.

There is no doubt that the East Asian region is in the cutting edge of digital innovation, including using CBDCs. Malaysia could be a dynamic centre of innovation in this field.

Tan Sri Andrew Sheng writes on global issues that affect investors

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