How Currency Dies
The Central Bank has announced that it is evaluating the creation of its digital currency. The novelty, if confirmed, will come in the wake of Pix and Open Banking, the banking data sharing system about to be launched by the monetary institution. One could say that these are the three jewels in the crown of the current Bacen team and with the potential to transform the financial environment in the country, just look at Pix.
The digital currency represents values deposited in a virtual and individual wallet, linked directly to the Central Bank. The currency can be transacted through a central bank app or the intermediation of commercial banks. If I want to make a payment, for example, I transfer the value from my wallet directly to another one. It is different from the Pix because the money is not insured by commercial banks, but by the Central Bank, just like the physical notes we carry in our wallets.
The digital realm is not intended to replace the root real. It makes more sense to think of them as complementary as the digital currency promises to make everyday financial transactions even easier. Through the integration and interoperability of the system, some of its advantages would be a wide system of payments and transfers among Brazilians, as well as between the State and citizens for the transfer of public funds, such as emergency aid.
The only Central Bank that has already launched its digital currency is the Central Bank of the Bahamas. The main justification was financial inclusion since the country is made up of islands that make banking difficult for the inhabitants. The digital currency, therefore, would serve to finally connect them.
The same justification, in turn, does not serve the Brazilian case. Unlike most countries, Brazil has recently launched an advanced instant payment system (Pix) that already fulfills the function of facilitating transfers, in addition to fintechs that are including the unbanked.
Beyond transfers, however, digital currency can play three other important roles: (i) the use in innovative mechanisms such as smart contracts and programmable money; (ii) the facilitation of cross-border payments via international agreements between central banks (exchanging real for dollar, for example, without necessarily going through exchange houses); (iii) the traceability of money as prevention of money laundering crimes.
For now, these same functions are only performed by another instrument that unites technology and currency, the so-called cryptocurrencies. It is symptomatic that several central banks around the world, including Brazil's, have accelerated their digital currency forecasts shortly after the announcement that Facebook is launching its own cryptocurrency, Diem. Facebook's currency is based on the stable coin model, whose "stable" refers to the stability resulting from equating its value to the dollar, allowing it to function as a means of exchange in the most diverse payment transactions, unlike bitcoin (the first and most famous cryptocurrency) which does not serve well in routine transactions because of its volatility.
Although backed by the dollar, Facebook's Diem would function in a decentralized manner and without the intermediation of any Central Bank, as designed by Satoshi Nakamoto, the inventor of bitcoin, in its purpose of enabling financial transactions between two agents independent of a third party guarantor (in life as it still is, when two people exchange a commodity for money, the third party is the Central Bank that "certifies" this money, and that's so our banknotes have Campos Netto's signature).
Central Banks fear that the mass use of cryptocurrencies will deprive them of control over monetary policy, jeopardizing the fulfillment of their core objectives of monetary stability and price control. The risk is that the flight from state money to private currencies will render ineffective the instruments that the regulator currently has to control the quantity of money (interest rates, printing money, compulsory deposits by banks, etc.) and the monetary authority will end up deprived of the means to control inflation or smooth the business cycle.
In the case of central bank digital currencies, these are not a mere response to the digitalization engendered by the pandemic, but a response to the possible impact of cryptocurrencies on domestic currencies. The goal is to provide better services to citizens (whether in terms of the speed of payment systems, smart contracts, or cross-border payments) to dissuade them from using alternative means of payment. Central banks have finally realized that if they do not adopt efficient and inclusive instruments, people will soon adopt other currencies. The challenge is on.