4 keys to understanding the digital currencies that replace paper bills (and why they have nothing to do with bitcoin)

When someone talks to you about digital currencies, it is likely that the first thing that comes to mind is cryptocurrencies such as bitcoin.

However, there are other digital currencies, virtually unknown, that are making their way silently into the corridors of the upper echelons of the financial world to replace paper bills and metal money.

They are digital currencies issued by central banks (CBDC, for the acronym in English / MDBC, in Spanish).

It is the digital version of the traditional currencies that people use every day, such as the dollar, the euro or the yuan.

At the end of June, the European Commission came up with a proposal to launch the digital euro.

According to this scheme, the traditional one euro coin would have a value exactly equal to that of a digital euro.

This new currency would be issued by the European Central Bank (ECB). a status that makes it as official as its physical equivalent.

In this sense, these digital currencies – already implemented in multiple countries – are the antithesis of cryptocurrencies.

Because? because cryptocurrencies are not issued by a central bank and their value is constantly changing.

Investors who are willing to take risks participate in the cryptocurrency market, as prices can skyrocket one day and fall the next.

In short, no one regulates their value and they move freely through a technology called block chain (or blockchain), while “public” or “official” digital currencies work the same as traditional money, only in an electronic format.

“The digital euro allows citizens to pay with public money,” says Valdis Dombrovskis, Executive Vice President of the European Commission.

Ecuador, one of the countries analyzing the adoption of digital currencies by central banks worldwide

“Having a digital wallet topped up in euros on your phone -or any other device- is the same as having coins and notes in your pocket”he added.

The final law must be approved by the 27 member states of the European Union. If that happens, the ECB is expected to give the green light for a digital euro in the coming months, so that it can be launched in 2027.

Below we tell you four keys to understanding how digital currencies work and what advantages and disadvantages they have.

1. How they work

The digital currency issued by each country’s central banks they are the electronic version of traditional money.

So instead of printing paper bills or metal coins, a country’s central bank issues its own money in electronic format.

One of the essential differences from the current system is that these currencies they do not require a bank to be the intermediary for the transaction to take place.

Theoretically, you could make wire transfers as if you were handing over accounts to another person or company.

Digital currencies are expected to lower the cost of transactions online made through commercial banking and that they favor those with lower incomes and non-banking segments of the population.

Among the various proposals to implement the system on the table, some experts have proposed creating universal bank accounts at central banks for all citizens.

But the truth is that each country or monetary zone that decides to issue this type of currency will set its own rules.

That’s the basic idea of ​​an official digital currency, although there are many unanswered questions for now as the world’s major economies are still analyzing its potential benefits.

2. What countries do they exist in?

China was the first major economy in the world to launch a digital currency in parts of its territory in 2020.

It is estimated that the digital yuan is currently used by some 260 million people and it is the intention of the government to expand it to the whole territory.

A total of 130 countries are exploring digital versions of their currencies, nearly half of them in more advanced stages of development, pilot or launch, according to Washington DC-based think tank Atlantic Council.

All countries of the Group of 20 (G20), except Argentina, are in one of these phases.

Eleven countries, including several in the Caribbean and Nigeria, have already launched digital currencies issued by their central banks, said the study center.

The Bahamas, for example, a small country with barely 390,000 inhabitants, has become a large laboratory due to the sand dollars (sand dollarsin English), the world’s first digital currency issued by a central bank.

The initiative is slow to take off because the majority of the population does not take advantage of it, a problem that other countries have also faced.

Two other major emerging economies, such as India and Brazil, have plans to launch digital currencies in the coming years.

At the center of this panorama, the country with the strongest currency in the world, The United States is nowhere near plans to create a digital dollar.

From the White House, in March 2022, President Joe Biden directed government officials to assess the risks and benefits of creating a digital dollar.

But the digital dollar is not part of the topics discussed on the country’s economic agenda.

Sweden remains one of the most advanced countries in Europe with its pilot programwhile the Bank of England is still working on a possible digital pound that could be up and running by the end of this decade.

Australia, Thailand, South Korea and Russia plan to continue pilot testing.

Despite the growing interest in official digital currencies, some countries that have launched them, such as Nigeria, say their adoption has been disappointing, while Senegal and Ecuador have canceled their development plans for these types of currencies.

3. What are the possible benefits

Digital currency providers say they will help financial inclusion for people outside of commercial banking and promote technological innovation, transaction efficiency and economic development.

In theory, the change would contribute to a cost reduction because the system does not rely on commercial banking as the means of payment is directly dependent on the central bank.

Indeed, in the case of the digital euro, it is assumed that the European Central Bank would have no commercial interest in storing, managing or monetizing user data.

Those who support the project presented by the European Commission claim that a digital euro would make it possible to pay on a large scale with “a form of public money”. accepted, cheap and safe”.

In addition, it is estimated that the use of digital currencies could deter certain financial criminal activities to the extent that it would be easier to identify the sender and recipient of the transfers.

4. What are your risks

If there is a digital euro in the coming years, the European Central Bank is not expected to impose user fees.

But that does not mean that using digital currency is completely free. It is not yet clear what the role and costs will be of potential intermediaries who will provide services to make the forex market work.

It is also not known what the relationship with the commercial banks will be like.

In addition, critical voices are concerned that central banks have detailed information about all user transactions in countries where there is insufficient transparency and the information can be used for political purposes.

Commercial banks are concerned that large numbers of depositors will eventually leave the banking system, a factor that could jeopardize a significant part of their business and, in extreme cases, lead to potential bank runs.

However, experts have said that potential money leakage from commercial banks can be easily controlled by placing limits on the amount of digital currency a given customer can hold.

Another criticism that has been leveled at the system is that since all operations would be centralized, there is a risk that a given central bank will make arbitrary decisions as it can create or eliminate money in an instant.

From another point of view, there is also the risk that a well-managed foreign currency could become digital in lieu of a particular local currency.

Ultimately, experts say, everything will depend on how the system of digital currencies issued by central banks is implemented according to the model defined by each country.