By Matt Long, OSL Head of Distribution and Prime
It’s April 2020, and the world is witnessing substantially more financial and social uncertainty than it did during the peak of the financial crisis in 2008-2009.
Whilst significant credit and financial markets dislocation was the cause for panic during the financial crisis over ten years ago, today’s threat to global financial stability is the coronavirus or COVID-19—a pandemic that has sent markets into free fall and societies into self-isolation, disrupting social and economic fabric at a scale not seen since the 1930s.
Central banks, in their traditional role as arbiters of competition in payments and the single source of money supply, have again become key players in ensuring stability in markets and society. But unlike in 2008-2009, the financial landscape has changed beyond recognition.
The ever-expanding adoption of digital assets such as Bitcoin, stablecoins and security tokens (a.k.a. security token offerings, or STOs), and the underlying technology, blockchain, are challenging incumbents in the financial industry like never before. Moreover, central banks are now also increasingly embracing the technology.
Several major central banks have been linked to digital currencies, notably those of the United States and China. On April 6, the South Korean central bank announced a pilot program to explore the logistics around implementing a digital currency.
As entities trusted with economic normalisation, central banks have the power to endow digital assets with value (via widespread use), network externalities (the more they’re used, the more they’re useful), and legality (compliance to transactions regulations).
To move the needle on digital asset normalisation, central banks can ramp up multi-stakeholder conversations across industry, government, and academia in four important ways:
- Lead discussions in policy-based regulation
- Advance conversations in interoperability and standardisation
- Promote central bank digital asset issuance
- Push wide adoption
First, central banks have to take a multi-stakeholder approach to regulate digital assets. For instance, should digital assets be considered payment systems, banking or deposit instruments, securities, a combination of these, or an entirely new asset class? As authority figures and policy creators, central banks can take a leadership role in this, supporting the efforts of intergovernmental organisations such at the FATF which are already engaging with digital asset-related policies.
More broadly, regulation will include areas such as competition in payments, cybersecurity, intellectual property, data privacy, consumer protection, legal certainty, and sound governance.
Second, central banks have to take the lead on conversations to establish universal technological standards for digital assets and blockchain technologies.
By leading the conversation around interoperability between blockchain-based currencies and legacy platforms and institutions, central banks can leverage their networks and experience in the financial system.
Digital asset issuance
Third, central banks need to take a multi-stakeholder approach to move the needle forward on issuing their own digital assets—or central bank digital currencies (CBDC).
Despite formidable challenges to realisation, CBDCs, whether token-based or account-based, will allow for uniformity and stability in national or regional digital assets.
By issuing CBDC’s to retail customers, for instance, a proportion of retail deposits may transfer to central banks, and such assets can be convertible to commercial bank digital assets at a 1:1 exchange rate—and thereby normalising and expanding their use in the financial system. CBDCs also increase the seigniorage value of the underlying currency to the central bank (since the marginal production cost of new tokens is close to zero), resulting in an economic gain.
Importantly, as in the case of account-based CBDC’s, central banks will have to verify the identity of digital asset holders to comply with KYC and AML/CFT rules. This will enhance trust in an industry where lack of trust has been a stumbling block to wider adoption.
With the current, coronavirus-induced emphasis on increased personal hygiene, there has been a rapid acceleration away from using cash and in favour of digital payments endorsing further digital payments and the use of digital assets.
Broad geographic adoption
Fourth, central banks—in their traditional role as arbiters in the financial system with wide networks—can lead policy negotiations nationally, regionally, and internationally to create a geo-political and financial environment that favors greater adoption of digital assets.
While the current situation is creating serious headwinds for many economies and industry sectors, there is reason for optimism for digital assets, including CBDCs.
What the COVID-19 pandemic is demonstrating, is that all industries and governments need to accelerate their adoption of modern technologies for socioeconomic continuity purposes.
At OSL, we believe the current situation is also clearly accelerating what has already been in the works for some time, namely that traditional financial institutions, including central banks, are ‘going digital’ – and digital asset adoption is happening faster than ever before.
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