Commentary: The Implications of COVID-19 on Digital Currencies and Financial Institutions
By Aaron Henry
Against the backdrop of the 2008 financial crisis, an anonymous whitepaper entitled “Bitcoin: a peer to peer electronic cash system” was released in the depths of the internet. Dubbed ‘internet money,’ Bitcoin would be the basis of a decentralized global financial system, with a money supply that was guaranteed by algorithmic design to never surpass 21 million ‘coins.’
Ever increasing scarcity would ensure that, unlike the US dollar which has lost 96% of its purchasing power since 1913, Bitcoin would increase in value over time, but only if it received mass adoption and became fungible. In short, it would serve as a safe haven asset, not dissimilar from gold, to manage economic crisis and give holders autonomy from the macroeconomic policy of central banks.
Up until recently, central banks and financial institutions took little notice of Bitcoin and its project to decentralize monetary policy, and indeed there was seemingly little need to pay much attention to a digital currency that for much of the last decade lived in the backwaters of the internet. In fact, Bitcoin’s early life was largely linked with money laundering, as payment in ransomware attacks, and other forms of criminal activity. As such, its real world application made it very hard to take seriously as challenge to the current monetary system.
This doesn’t mean that central banks had no interest in borrowing blockchain technology, the system that underpinned Bitcoin. In fact, 18 central banks were developing their own blockchain-enabled digital currencies (CBDCs) earlier this year to create faster payment settlement. However, COVID-19 related fiscal interventions, systemic economic uncertainty and our drift into a multipolar world order, may force central banks to adopt CBDCs in a hurry as a hedge against an ascendant Bitcoin.
The world over, governments have unleashed massive stimulus programs necessary to keep people at home, cover rents, and help businesses survive in economies that have been effectively put into suspended animation. These stimulus packages have been funded through significant increases in debt and by printing money. Wall Street estimates suggest $4.5 trillion of new dollars will be created by the US administration to buy up otherwise distressed assets. For reference, the federal balance sheet stood at $3.7 trillion after the 2008 financial crisis.
While the US has the advantages of being the world’s currency, it won’t see substantial devaluation as its value will hold up relative to other currencies that are facing the same economic headwinds. However, under these broad conditions of systemic devaluation you may see fiat currency exit into other assets such as gold and Bitcoin. If it is the latter, this may pose a significant threat to the ability of central banking authorities to control their money supply, especially as the decentralized network that underpins Bitcoin is beholden to no jurisdiction.
Under these conditions, digital currencies created by central banks may become necessary to ensure monetary sovereignty can be maintained. In short, a digital currency on a blockchain ledger would allow central banks to tighten their grips over their currencies, speed up transactions, and ensure financial transactions remained in licit channels.
Indeed, with a blockchain based system behind it, CBDC’s could be used to optimize tax systems, and eliminate the movement of funds from Canada into illegal tax havens, and other portals through which money illegally leaves the Canadian economy. It could also reduce the costs and increase the speed of Know Your Customer for Canadian banks, as information could be tracked and effectively centralized. What might some of the broader implications of this be?
Cashless and Contactless?
Physical currency is already waning. A CBDC would accelerate and complete the transition to a cashless monetary system. This no doubt would be welcome both by merchants and financial institutions, but it would also be of value in a world where COVID-19 transmission has yet to be managed by a vaccine. Removing physical money creates one less vector of transmission.
Micro-tools for Macroeconomic Policy
Canadians may face an increasingly complex set of economic signals. Low interest rates could continue to reduce home savings, a recession and higher sense of systemic risk could create significant deterrents for investment both by small and large corporate firms. In addition, record debt levels across the board, households, corporate and public could weigh on the Canadian economy for some time. The Parliamentary Budget Officer recently suggested the federal deficit could reach $256 billion by the end of the year, a combination of COVID-19 emergency spending, falling economic output, and the carryover a substantial deficit spending over the last five years.
CBDC could be used to create added real-time added incentives for certain forms of economic behavior, for instance rewarding investment decisions for corporate actors and also rewarding homes that save or pay down debt to compensate for hindered market signals given the low interest rates. CBDC could make these type of highly targeted interventions from Central Banks possible and cheap, but would come at the cost of privacy. In particular, by the Bank of Canada’s own admission, a central bank backed digital currency would allow more information than ever before to be collected about Canadians as every type of payment received and sent would not only be collected, but effectively shared and cross-referenced with third parties. While this would allow for certain types of behavior to be rewarded, the converse could just as easily hold true.
Geopolitics and Technology Converge
One of the foundations of the Bretton Woods system, on which the global finance system rests, is not only on the supremacy of the US dollar but the supremacy of the US as the jurisdiction through which global trade exchanges are settled through, known as the Fedwire clearing house in the US. If we continue to see trade war escalation, and a multipolar world where China seeks to develop a financial system beyond Bretton Wood Institutions, CBDC’s will play a vital role. In particular, CBDC reconciled by blockchain technology would allow for payments to take place without US clearing houses playing an intermediator role in global trade. Fragile geopolitical relations and a potentially strained global financial system helmed by the US, could see more countries introduce CBDC’s as a means to gain greater sovereignty over their global financial transactions.
Like so many things today, the future of Central Bank Digital Currencies (CBDCs), and Bitcoin for that matter, is anyone’s guess. But smart money may be betting on, well, smarter forms of money to come out ahead. If this comes to pass, Canada will need to ensure its approach to CBDCs is streamlined to improve its economic competitiveness, support more precise fiscal policy and above all ensures it can navigate an increasingly uncertain global order.
*Aaron Henry is the Senior Director of Natural Resources and Sustainable Growth at the Canadian Chamber of Commerce.
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