The Digitalization of National Currencies

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The Digitalization of National Currencies
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Libra, Libra, Libra. In 2019, everyone in the crypto world and perhaps outside of it became acquainted with it. Facebook wanted to launch its own global digital currency. It soon became clear that a large number of well-known parties such as Paypal, Ebay and Mastercard joined the initiative. This ambitious plan did not escape the attention of national governments, central banks and regulators. These institutions worried about what would happen to user privacy if the digital currency of Facebook were to become really large. The exchange of all kinds of data is almost entirely in the hands of companies, but the exchange of value is an exception to the rule. The project was therefore quickly curbed by these institutions. First, it was time to investigate the potential impact of Libra on society and its traditional economic structures. Partly because of that the above partners withdrew from the project. Although the project is not off the track, the momentum seems to be slowing down.

It has, however, shaken national governments and central banks. In the corridors of government and bank buildings people were probably already whispering about “official” national digital currencies. With the statements of Christine Lagarde, Head of the International Monetary Fund, the establishment of national digital currencies seems to be pushed up on the priority list. Many Crypto investors can clearly remember that Chinese President Xi Jinping announced that he would go “all-in” on blockchain technology in October of last year. There are also sounds from the United States that, for example, a digital central bank currency is inevitable. Will the development and launch of national digital currencies gain momentum and what can we expect in 2020?

The original partners of the Libra initiative

Are there some examples of National Digital Money?

What is probably unknown to many is that outside of Europe, China and The United States there are already a handful of digital national currencies. Ecuador, Senegal, Singapore, Tunisia and Venezuela, for example, already have such a currency. In addition, many experiments are underway in countries such as Dubai, Ecuador, Russia, Iran and Sweden. Although no experiments with the Euro are known yet, there is a need if we look at a paper written by The Association of German Banks. They wrote about the role of banks in the creation of digital currencies.

What needs to be done to successfully launch National Digital Money?

The Association of German Banks examines how banks deal with the changing environment, their competitors in the field of digital currencies, how they can contribute to the innovation of digital currencies and of course also how they can ensure that the (traditional) financial system remains stable during a possible evolution. The Association has fairly clear positions ranging from topics like stability and government to tax aspects. This paper gives us a clear explanation of what needs to be done before there is a successful way to launch a national digital currency.

Stability & risk factors

A stable currency is one of the key factors for having a healthy economic system and therefore a sovereign state. The introduction of digital money must not jeopardize this stability. A global digital currency such as Libra can jeopardize this because sudden boundless inflow and outflow of capital can upset the economic equilibrium in states. Traditional economic tools such as currency reserves, interest rates and exchange rates would have little effect to keep or restore balance in the event of an enormous growth of a worldwide and privately run currency such as Libra. A worldwide corporate currency such as Libra therefore seems off the table for now. So let’s have a look at national digital money.

While national digital currencies respect national borders, there would still be more than a handful of risk factors for national and global economies. The issuance and custody of national digital money must fall under the rules regarding bank licenses and there must be interoperability with the traditional money (system) within the own country and between other countries. Bank customers, individuals and organizations, must of course stay protected with high and fitting standards in terms of financial errors and privacy related issues. Their rights and obligations with regard to the use of digital money in relation to other parties must be changed before national digital money can really work without harming economic and societal structures.

The nature of national digital money must also be clearly established for tax reasons. Are they goods or currencies? The nature has a huge impact on the registration requirements for companies and individuals and on how they deal with national digital money and how much tax they pay or receive. All this can only be achieved with clarity and certainty in the form of a suited legal framework and an associated supervisory apparatus. But what exactly is such a crucial innovation within digital money and is it really that important for countries to speed up its development?

Christine Lagarde, Head of the International Monetary Fund

Technological innovations and the role of Digital Money

As many readers of this article may recall, Chinese central banks announced that they wanted to switch to a digital version of the Renminbi. China is at the forefront of, for example, Internet of Things (IoT) and 5G network technology development and is gearing its economy and legal and political environment to accelerate these technological developments. What many do not know is that Internet of Things and blockchain technology are a crucial link. This is because Internet of Things ensures that devices can communicate complex data with each other and can exchange value in the form of data and digital money through blockchains. There is a crucial innovation within the blockchain industry to get the most out of this technological link: smart contracts. Through smart contracts, agreements and payments can be made automatically between devices and people and devices without any interference.

Innovative countries and banks therefore focus on developing and facilitating programmable digital money. It therefore seems highly likely that digital money will eventually work on the basis of Distributed Ledger Technology (DLT) with a possible account-based system as an intermediate step to DLT to keep up with competition. A logical aim is to digitalize existing currencies, like the EURO, in order to keep the current system as stable as possible during any transitions. However, this requires a pan-European cooperation since the Euro is a cross-border currency and because overarching technological standards and contractual rules are necessary in order to scale an initiative.

The exchange between a theoretically infinite number of devices makes it very important that the payer, even though it is account-based or DLT, is identifiable to prevent cyber crime. This means that as well the people as the devices need to have some form of ID. However, the rules and the regulators should not be too restrictive for successful innovation. It is clear that, outside of technology, defining the nature of digital money and clarifying the rights and obligations of parties involved such as governments, banks and customers must be clarified and renewed so that they match digital money without stifling innovation. The biggest challenge of 2020 seems to be to give shape to the legal framework to protect traditional structures and minimize risks while innovation can thrive.

Different types of digital money explained

2020: New legal frameworks, high standards and smart regulations

National digital money should be classified and it should comply with the really fitting economically-oriented regulatory standards to gain enough public trust for use as a means of exchange on scale. This then involves international standards to prevent cracks in and polarization between economic structures.

In the case of private initiatives: if Libra walks like a bank, quacks like a bank and looks like a bank, it must be regulated like a bank to coop with exchange, liquidity, run and repayment risks and to create a level playing field. This also applies to traditional banks. However, they should also not be excluded from the level playing field without any clear reasons. It must be a ‘fair’ game.

In the meantime regulatory frameworks should only depart from an economically-oriented and innovation-oriented approach if DLT solutions cause regulatory gaps. This is to prevent innovation to slow down as countries and their banks will unlikely be able to stay competitive if they go stricter. Therefore there must be a clear competition law to facilitate international payment solutions and to protect banks from losing higher ground to big tech companies. It is also needed to facilitate a smooth transition in how money is exchanged and how services alongside money exchanges are provided to individuals and businesses.

Those individuals and business and their devices need to stay or become verifiable during every transaction that takes place to prevent cyber crime or fraud. There needs to be a uniform global identity standard that prevents subjects to go anonymous and that helps regulators to keep track. However, the users of those payment networks need to be protected in order to minimalize financial risks and privacy risks. Those risks need to be minimalized in some sort of data protection standard and accompanying laws and there need to be contract laws and protection standards to coop with for example financial losses customer exchanges.

Last but not least it needs to become clarified through tax laws how individuals and organizations do their bookkeeping. Therefore digital money as an object needs to be defined as goods or as means of exchange and it needs to be decided if digital money is subject to VAT.

Conclusion

So, will the development and launch of national digital currencies gain momentum? Definitely. Besides Libra, there is a lot of competitive pressure from China in the field of new technologies such as Internet of Things and 5G network technology. These technologies potentially enable people and machines to exchange complex data and value. To prevent polarization, the United States and Europe must shift the development of digital money higher on the priority list.

But what can we expect in 2020? In addition to the further development of programmable money and international partnerships and platforms, the focus will most likely be on the development of new legal frameworks, high and fitting standards for digital money and smart regulations. The challenges will be to protect banks and countries against unfair competition and the disruption of the current economic system without stifling innovation. In addition, customers, both individuals and banks must be financially protected in a new world of digital money. This also applies to the data of these customers, although they must remain identifiable to prevent crime. In addition, there must be clarity about taxes on digital currencies.

2020 promises to be a year in which we see the successful development of national digital currencies and the equally successful development of rules and regulators to accommodate them adequately with the main goal to keep our economies stable during transitions.

Contributed by @LordCatoshi

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