THE FUTURE OF DIGITAL CURRENCIES

THE FUTURE OF DIGITAL CURRENCIES

The extraordinary technological advances we are witnessing open the door to more widespread use of digital currencies in the not too distant future.

More than ten years have passed since the creation of bitcoin (1), still the most widely used digital currency, and the weight of cryptocurrencies has grown to heights hardly imaginable in its early days.

The aspect we want to try to analyse today is the concrete aspect of the spread of bitcoin, namely the fact that it has forced states and regulatory bodies, such as central banks (European and others) and the US Federal Reserve, to get to work and undertake the complex task of providing their own centralised digital currency.

Why is this happening?
After all, a banknote, as a claim on a central bank, is the safest form of money. But only commercial banks have access to central bank reserves. A central bank digital currency (CBCD) would extend this access to everyone. The public could hold accounts at the central bank, or hold central bank money in privately issued wallets.

So the big concern for central banks is nothing more than to stand idly by and give up on an ‘electronic currency’ at the risk of undermining the supremacy of central banks in world markets.

But the challenges behind digital money for Central Banks are complex: security, the role of Central Banks themselves, the privacy of transactions, and even the technological challenge that would be involved in setting up the system.

In an attempt to test the waters, the US Federal Reserve (Fed) published a report last year on the pros and cons of a hypothetical digital dollar. Similarly, the European Central Bank approved ‘the start of the research phase of a digital euro project‘. The date set by Brussels for the realisation of the digital euro is 2026. China is far ahead, having already begun testing its own electronic version of the yuan in some regions and activated several initiatives to encourage its adoption, from lottery prizes to the creation of a digital wallet (e-CNY).

This, however, concerns the eventual (or for some countries now concrete) creation of their own currencies with the implementation of currencies in digital form, while on the other hand we must also point out how the authorities of the various countries are trying to react to the spread of cryptocurrencies in their domestic economy.

Last year, for example, the People’s Bank of China (PBC) declared cryptocurrency transactions, mining, and even cryptocurrency-related advertising illegal. Russia and India are following a similar line. In Europe, the authorities have opted for the regularisation of crypto-assets; for example, in Spain, a few days ago, the Tax Agency issued a binding opinion stating that NFTs will be taxed at 21% in relation to the activities of creating and buying and selling them by companies or artists (2).

In view of the fact that today’s globalised world has already shown that the direction of the future in the financial field is, without a doubt, the widespread use of digital currency and, at the same time, that this trend frightens the Central Financial Authorities what they are trying to do is the creation of a Central Bank digital currency (CBDC).

Its main difference to decentralised cryptocurrencies, such as Bitcoin, Ethereum or even the stablecoins (3) that have emerged to avoid volatility, is that it would be issued by the Eurosystem and offer the security of a central bank-backed currency.

Digital money, as the ECB has repeatedly stated, would not replace cash, but would seek to provide a service to citizens in their daily electronic purchases. In the case of Europe, for example, one of the objectives is precisely to maintain the primacy of currency over other payment methods.

Why are they taking this step?
Authorities such as the European Central Bank and the Fed in the United States have decided to move in a scenario characterised by several factors. The main one, perhaps, is the rise of electronic transactions and the loss of weight of cash, a phenomenon that has been going on for years and is now reinforced by the pandemic.

In Europe, the statistical curve on the use of cash as a means of payment has been steadily decreasing since 2014. “The creation of a CBDC would also protect us from the risk that a public or private digital means of payment issued and controlled from outside the euro area could largely replace existing national means of payment,” the ECB itself argues.

What will the world of money look like in five or ten years? We could imagine a world in which many people hold digital wallets with a mix of money in traditional bank accounts, stablecoins managed by private companies and perhaps one or more CBDCs, moving them around according to global conditions. On the other hand, no one knows how far stablecoins and CBDCs will be able to co-exist. Meta (formerly Facebook), for instance, was planning to launch its own stablecoin. But the project was blocked by US regulators, who were concerned about Meta’s objectives and the possibility that stablecoin could be used to finance illicit transactions inside and outside its borders.

With their CBDCs, governments are precisely trying to recover lost sovereignty and combat the threat to state monopoly posed by cryptocurrencies or initiatives such as Facebook, which despite its potential seems to have its days numbered.

In this context, it should be noted that the US government is very concerned about the creation of the Chinese digital currency – the e-yuan (4), which we can trace back to 2014 – which has as its clear and declared objective the internalisation of the yuan in an attempt to defend its monetary sovereignty from the currencies of the US tech giants that will pivot on the dollar.

Problems and advantages of digital currencies

However, investing in digital currencies has advantages and disadvantages, both in the more popular and established ones, such as Bitcoin, and in those emerging in 2022. This is the case with Lucky Block, one of the noblest in the sector. We present the pros and cons of investing in digital currencies.

Cons:
If individuals were allowed or even pushed to manage cryptocurrency accounts with Central Banks or if CBDC tokens were distributed for the day-to-day management of economic transactions without the intermediation of conventional banks the risk would be that people who today have deposits with banks would withdraw them to convert them into CBDCs with the consequence that conventional banks would be drained of their liquidity weakening their ability to lend and invest by altering their institutionalised role.

There are other equally insidious challenges. Perhaps the most debated issue is that of transaction privacy. One of the great attractions of cryptocurrencies is precisely their decentralised nature or the fact that they can pass under the ‘radar’ of taxation, which explains, for example, their veto in China. Achieving the same level of anonymity as cash transactions seems difficult, but the ECB has already worked to strike a balance between confidentiality and verifiability. A maxim that must also be made compatible with the technological effort that the system will require and a level of security that shields it from cyber attacks.

Volatile investments due to speculation
Although the price of a cryptocurrency can reach record levels, with the resulting benefits for investors, it can also collapse just as quickly. Therefore, if you are looking for a stable return, cryptocurrencies may not be your best choice.

Cryptocurrency markets rely heavily on speculation and their relatively small size makes them more vulnerable to price fluctuations. This can also wreak havoc on the value of currencies, one of the main drawbacks of cryptocurrencies.

Long-term performance is unproven.
Although cryptocurrencies are widely known and booming, they have been around for little more than a decade. Stock markets, on the other hand, have been around for over 150 years. By the way, gold has proven to be a carrier of value for millennia and stock exchanges do not realise that digital currencies are emerging as competition. On the other hand, no one knows what will happen to cryptocurrencies in the future.

Pros: Instead, let us look at some of the important advantages that digital currency offers.

For instance, it facilitates the traceability of transactions and provides more tools in the fight against money laundering and terrorist financing.

Another advantage is that it lowers the production costs of cash and reduces the risk that a handful of companies may concentrate on electronic payment services, eventually harming competition and consumers themselves. These are not the only strengths, of course. The role of central banks themselves could become more influential by establishing a direct relationship with citizens or by strengthening their ability to influence inflation or growth.

The possibility of big profits
There are thousands of cryptocurrencies on the market, each with its own characteristics and peculiarities. However, all digital currencies have one thing in common: they have a tendency to experience sudden peaks and troughs in value. This is because prices depend on the supply of coins on the blockchain and the demand of buyers.

This supply and demand dynamic can generate significant profits. The price of Ethereum, for example, almost doubled from July to December 2021, lucky dates for those who invested at the right time.

The digital infrastructure behind cryptocurrencies is the blockchain, a decentralised data storage ledger that keeps track of all transactions that take place on it: once entered, the entry can no longer be deleted. Since the blockchain is stored in a decentralised manner on several computers, hackers do not have the ability to access the entire chain at once, so the recorded information is safe.

Since the modern world is teaching us that one of the main virtues is to adapt to rapid change, cryptocurrencies represent this change on an economic level and the need to at least understand its usefulness.
It will then be up to us to choose how and how much to use them.

Milan, 23 June 2022
Niccolò Lasorsa Borgomaneri

Notes:
(1) Satoshi Nakamoto, the faceless man who invented Bitcoin https://www.rollingstone.it/tv/documentari/satoshi-nakamoto-luomo-senza-volto-che-ha-inventato-i-bitcoin/598427/
(2) https://cincodias.elpais.com/cincodias/2022/05/11/legal/1652286242_193855.html
(3) Stablecoins, why they are successful and the relevant regulations in https://www.agendadigitale.eu/cittadinanza-digitale/pagamenti-digitali/stablecoin-le-ragioni-del-successo-le-sfide-da-affrontare-le-normative-in-vigore/
(4) China: The Great Silent Growth of the Digital Yuan by Marcello Minenna in https://www.ilsole24ore.com/art/cina-grande-crescita-silenziosa-yuan-digitale-AEufHqDB