As moves towards digital currency gather speed, businesses need to prepare for a world that transacts in digital dollars.
he Chinese are trialling it. The UK Treasury and the Bank of England have a taskforce on it. The Bahamas actually has one.
After years of talk, central bank digital currency has suddenly become serious business. Once wary of digital currencies, central banks are now learning to love them.
Digital currency – colloquially known as GovCoins – allow people to transact directly with a central bank, bypassing conventional retail banks and institutions.
Instead of holding an account with a retail bank, you would do so direct with a central bank through a digital interface – such as through one of a growing number of digital wallets.
Central banks, traditionally not involved in transactions, would be positioned at the coalface, leaving commercial banks and lenders to reassess their role in the finance world.
With a flurry of cryptocurrencies now in the market and systems of economic exchange expanding outside the reach financial market regulators, central banks are trying to regain control of the financial system.
G20 finance ministers believe central banks must take a lead in the currency space or risk losing their ability to manage the economic cycle.
For as long as people have repeated the refrain of the two certainties in life – death and taxes – money has been, in its various guises, part of society.
But minted coins and paper money, not so long ago at the cutting edge of technology with anti-forgery and security measures, now make up just two per cent of global transactions.
While much of the world already moves money electronically, a digital currency has no physical form and transactions would occur through a digital wallet.
New money will, at least for a while, sit alongside old money – but a move to digital currency makes sense because fiat currency and commercial banks have fallen short of expectations in the age of the significant integration and automation of financial technologies. These need a digital form of money to operate at their peak, says Julian van Zyl, Digital Assets Practice Leader at Baker Tilly Cayman.
“The key advantages of a central bank digital currency (CBDC) are the speed of transactions and the cost of transactions, because it can eliminate the need for a host of intermediaries and you can really speed things up,” he says.
“At present it’s quicker for me, for example, to transfer fiat currency from my bank in the Cayman Islands to a cryptocurrency exchange, buy cryptocurrency, send it to a cryptocurrency exchange in South Africa, sell it for Rand and transfer that Rand to my bank account, than it is to send a regular cash transfer from one international bank to another.
“In time, the adoption of CBDCs should make all of those electronic transactions a lot faster and cheaper as well.
“It’s very similar to the leap that was made from seashells to gold, and cash to electronic money. Now it’s just electronic money moving to digital money.
“While central banks and governments are investigating digital currencies, businesses need to start preparing for a world where digital dollars will be used in transactions. It’s a different form of the same thing.”
What’s behind the digital currency push?
Deepak Upadhyaya, Partner and Digital Technology and Risk Advisory lead for Baker Tilly WM in Canada, says China stole a march from most western nations in the digital currency race.
“China has been a frontrunner on the back of a directive from China’s President that it must be at the leading edge of two emerging technologies, AI and blockchain, and I would predict by the end of the year, there will be a digital yuan,” he says.
“They have already given away millions of dollars worth of the digital currency in real-world trials in a number of cities including Shenzhen, Chengdu and Suzhou.
“It’s even been delayed and if it hadn’t been for COVID-19, we would probably have seen a launch earlier this year or even late last year.”
“China has already given away millions of dollars worth of the digital currency in real-world trials in a number of cities including Shenzhen, Chengdu and Suzhou.”
Testing has now expanded into six regions in China after winning the public over in initial trials.
“They did it through the People’s Bank of China (PBOC), and distribution was conducted via a two-tier system.
“The PBOC will distribute the digital yuan to commercial banks and the commercial banks will be responsible for getting the currency into the hands of consumers.
“This could include services to allow consumers to exchange their coins and cash for digital yuan.
“The trial eventually moved to a province where they typically got a lot of tourists, so it was not just locals, but they started having tourists be aware of the fact they could pay with digital currency.
As of February of this year, The People’s Bank of China and the Central Bank of the UAE (CBUAE) will be trialling cross-border payment experiments.
This project, the ‘Multiple Central Bank Digital Currency (m-CBDC) Bridge’ aims to explore using distributed ledger technology for 24/7 real-time foreign currency transactions between countries,”Mr Upadhyaya says.
In the background, interest in cryptocurrencies exploded, leading to Ecuador actually accepting Bitcoin as an official currency, hastening nations to investigate how a digital currency might work.
“Canada is undergoing a huge review of its payment structure and trying to figure out how are we going to embrace digital currency,” he says.
“Estonia is further ahead, they’re, they’re in the process of doing trials and Caribbean islands are coming together to figure out how they issue digital currency – so I believe it’s probably a year or two years before we start seeing major adoption of digital currency.”
The tiny nation leading the world
At the opposite end of the size scale to China is the Bahamas, the Caribbean state of just 398,000 people – and the first nation in the world to have a central bank digital currency.
Known as the Sand Dollar, the digital currency was four years in the making before it rolled out across the nation’s 700 islands and cays in October 2020.
Ilzhem Aragundi, Senior Manager at Baker Tilly Bahamas, says the Central Bank of The Bahamas pushed ahead with a new digital platform in the face of commercial banks closing branches on some of the islands, as part of restructuring plans after Hurricane Dorian in 2019.
“Small subsets of the population on family islands can be a challenge to serve with a full brick and mortar banking footprint, given the inherent overhead costs and lack of economies of scale,” she says.
“Therefore, a digital solution provides an alternative for payments to be made easily without the traditional architecture.”
Ms Aragundi says accessibility, inclusivity, and human rights are at the core of the digital platform.
“The unbanked population, inclusive of those without a status in the Bahamas, will be eligible for a Sand Dollar wallet, obviously with reasonable limitations depending on tier and KYC requirements,” she says.
Digital currency suddenly became a lifeline for Bahamians in a time of crisis. The first trials in Exuma went ahead in December 2019, just weeks after the islands were devastated by Hurricane Dorian.
One of the most powerful weather systems ever to make landfall, the Dorian catastrophe left 74 people dead and many of the islands in ruins, particularly in the Abaco region.
“The trial began with 1,300 participants and 30 businesses, with another 1,800 participants on a waitlist, and the trial was oversubscribed by more than 500 people.
“Abaco was completely devastated, there was no banking system, there were no ways to connect, so the Sand Dollar was very welcome.”
It quickly gained popularity and within two months, the Sand Dollar was released on Abaco – where Dorian had destroyed the physical banking infrastructure, including ATMs and bank branches, leaving people without access to funds in a time of crisis.
“The island was completely devastated, there was no banking system, there were no ways to connect, so the Sand Dollar was very welcome,” Ms Aragundi says.
The COVID-19 crisis also played a role in the Government accelerating the trial program.
“Because it was so welcome, especially for small business, the central bank took the Sand Dollar from pilot production to a national rollout on October 20, 2020 and it’s now a central bank digital currency available to the general public.”
The digital currency is equal to one Bahamian dollar, which is equal to one US dollar, and it is backed by the foreign reserve. The only areas where fiat currency and commercial banks remain the sole option is lending and credit.
Ms Aragundi says the security elements around digital wallets, such as with dual or multifactor verification and not having to hold physical cash, reduces the likelihood of theft for small business, especially in small islands.
“The ability to transfer funds faster and more easily, with a fully auditable transactions trail, is ultimately what you want,” she says.
Bahamian people and businesses use the digital currency in everyday transactions and many organisations are moving towards processing salaries in digital currency, straight into digital wallets.
“There are moves now towards payroll solutions, especially during the COVID crisis and for those islands who are devastated on Abaco, to process at least part of payment of salaries with Sand Dollar payments, but not all,” she says.
“But our CBDC has been well received everywhere, it is welcome at point of sale, transactions are near-instantaneous and they are supported by online functionality.
“However, it is restricted only to domestic and local commercial transactions – if you’re in Australia, for example, you cannot trade through the platform.”
CBDCs and commercial banks
If central banks control daily transactions, it significantly impacts commercial banks and their business model. However, the extent of that impact will depend on the design of CBDC.
Mr Upadhyaya says the future of commercial banks is uncertain, and he believes they will have to evolve to remain relevant.
“I’ve worked with a couple of senior vice presidents in a few of the banks and they’re furiously trying to figure out what does the next 10 years in the banking industry look like?” he says.
“I don’t know that anybody knows at this point what that role is going to be going forward. But they will definitely need to be more aggressive, and gone are the days of charging $30 just to keep your checking account.
“Transaction fees are going to drop, they’re going to try and figure out different ways of revenue generation, and definitely they are going to stay focused on lending.”
Mr Upadhyaya says the open banking framework in the US and Europe could shape how banks evolve in the future.
“One of the competing practices for these commercial banks is this decentralised finance, which is really picking up. Decentralised finance (DeFi) is a blockchain-based form of finance that does not rely on central or commercial banks.”
“Banks are saying, ‘okay, if we’re going to start losing out on some of the direct-to-consumer type activity, then maybe we can become like a service provider and open up our infrastructure and back end, which traditionally was very guarded,” he says.
“By allowing private companies to be trading directly with us, we still continue to retain that market share but also open up a little bit more, so even if private companies want to do the transactions and services that we’re providing, we become a service provider”
Mr van Zyl believes commercial banks will still be important for lending and credit because central banks are unlikely to want to bear the risks.
“With lending, you’ve got the risk of default, which the Reserve Bank is not going to want to take. They are not going to want to be the lender for businesses building new properties or infrastructure projects,” he says.
“Commercial banks are definitely going to play a crucial role in the economy, ultimately they will still be lending and creating money.
“But a lot of the payment or processing is going to move away from commercial banks and I think companies like Visa or MasterCard are going to lose out significantly.
“You’ve got all of those micro sales, buying coffee, paying for items at the supermarket, that can all just be peer to peer essentially.
“One of the competing practices for these commercial banks is this decentralised finance, which is really picking up. Decentralised finance (DeFi) is a blockchain-based form of finance that does not rely on central or commercial banks.
“We’re seeing almost all of the new hedge funds launching into the Cayman Islands now investing in decentralised finance in some form. Adoption of DeFi is still in its infancy so we’re going to see a lot of movement there. And I think that that could really compete with commercial banks one day, it’s obviously on a very small scale now, but it will grow.”
The importance of education
Ms Aragundi says education has been – and continues to be – a big part of the conversation in the Bahamas because digital currencies are poorly understood.
“The Sand Dollar is a central bank digital currency and that means it is a centralised, regulated and stable part of The Bahamas’ finance chain,” she says.
“It is nothing like Bitcoin, it’s not a cryptocurrency.
“Cryptocurrency such as Bitcoin is private-sector issued and they are not represented by any part of the Government or central bank authorities.”
She believes one of the most important elements to embed the new way of transacting is engaging young people.
“A lot of people, particularly older people, don’t have bank accounts and in my experience, many people still like to join the queue and pay in cash, in person,” she says.
“But when you have a situation like COVID, your mum or dad cannot go out and pay the bills. So you have an emerging population that is training parents or grandparents to do that themselves.
“There are 1.7 billion people in the world that still don’t have a bank account, but 90 per cent of them have a cell phone.
“So while those people might not have a bank account, a phone and a digital wallet mean they can still pay their electricity bill.”
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