Digital Currency - What's the fuss?
June 16, 2020
By James Wall
There is a lot of talk about digital currency, particularly Central Bank Digital Currency (CBDC), but why all the fuss? Isn’t money digital anyway?
When you transfer funds from one account to another or one bank to another, no real currency changes hands. A digital book entry debits one account and credits another on a ledger maintained by the bank. The same largely occurs in the securities world as many assets have been dematerialised and security transfers occur as book entries on various registries/ledgers. This often occurs in real time via networks such as, RTGS, CLS and FPS.
So why the excitement about CBDC?
Current platforms typically work within a domestic context or within a permission network where all parties are trusted players or it is backed by a Central Bank. Settlement within that network or ledger is seamless as long as all parties and assets/cash are on that system and the ledger can be updated in a manner similar to a book entry transfer. We see this relationship start to breakdown when one wants to exchange cash/assets sitting on a different platforms/ledger or in different markets.
This is where Distributed Ledger Technology comes into play and why a CBDC is an exciting element in a potential global cross border, cross asset multi ledger platform. The pioneering work published by the Bank of Canada and MAS in the “Jasper Ubin Design Paper” demonstrated the potential to use DLT to settle cross border payments in a such “trustless” environment. The ability to use DLT and smart contracts allows the users to settle transactions in real time where each party may be unknown to the other. The ability to remove settlement risk and the associated credit exposures that occur in today’s systems represents a significant potential reduction on RWA, liquidity requirements and counterparty credit exposures within markets and even cross border markets.
CBDC as a digital token of exchange within such an ecosystem provides a further enhancement replacing potential counterparts risk associated with collateralised tokens with risk free Central Bank exposure.