The RSMR Broadcast - The fight back: central banks versus cryptos

07/09/21

The RSMR Broadcast - The fight back: central banks versus cryptos

There's no shortage of knowledge and expertise at RSMR! Every fortnight we get our heads together and talk about events in the world and how investments are affected by them. Our Broadcast tackles a wide range of issues facing investors from green gilts to the legislation of tech giants and unregulated investments to the changing face of infrastructure investing. We like to think of it as cracking content for the financial adviser. Have a read & get clued up...

 

What’s the big advantage to cryptocurrency? There’s no requirement for intermediation between transactions, cutting the middleman out, making it a cheaper, faster, and more transparent process. The key disadvantage is risk. Cryptocurrencies aren’t backed by an institution; if your money is stolen or you lose the password to your wallet, your investment is dead, making it an incredibly volatile business. Naturally, central banks are nervous about the fundamental edge that cryptocurrencies have, but there’s potentially a middle ground to be exploited where you can access the advantages of cryptocurrencies and protect your investment at the same time.

Domestic cryptos backed by their respective national banks are already in use in China and the Bahamas, allowing people to use a digital currency to pay for goods, safe in the knowledge that their money is protected. A Central Bank Digital Currency (CBDC) would make electronic money, issued by the Bank of England, available to all households and businesses, allowing everyone to make electronic payments in central bank money. If a CBDC were to be introduced, it would be denominated in pounds sterling, just like banknotes, so £10 of CBDC would always be worth the same as a £10 note and CBDC would be introduced alongside cash and bank deposits rather than replacing it. 

In the UK, we’re used to being able to transfer money in a matter of seconds, but this isn’t even a viable option in many countries, making cryptocurrency and the lack of necessary intermediation an attractive concept. When you send money between banks internationally, currency is converted, which takes time and has cost implications as there’s a requirement to pay an intermediary, a broker, for international clearing services.

The central banks of Australia, Malaysia, Singapore, and South Africa, alongside the Bank for International Settlements (BIS), are currently testing the use of CBDCs. Project Dunbar has recently been launched with the aim of sending currency between countries, allowing central banks and institutions to use cryptocurrencies and distributed ledger technology, the system that underpins digital cryptos, removing the currency translation effect, reducing costs and time scales for payments transferring into a different currency.

Cross border crypto transactions are already available but currently they can only be processed in the currency of the exporting country. The aim of Project Dunbar is to allow you to make a purchase from another country with a different currency with no delay, intermediary or costs. Let’s say you want to pay for a purchase from Amazon in the US; you press a button and your payment instantly goes across the Atlantic, changing from sterling to dollars.

Led by the Money Authority of Singapore, the Dunbar project aims to develop shared platforms for cross-border transactions using multiple CBDCs, allowing financial institutions to transact directly with each other in the digital currencies. Technical prototypes will be developed on different distributed ledger platforms and a variety of governance and operating designs will be looked at, enabling central banks to share CBDC infrastructures. Collaboration between public and private sector experts in different jurisdictions and areas of operation will benefit and fuel the project. The results are expected to be published in early 2022 and will inform the development of future platforms for global and regional settlements.

On a corporate level, the potential benefits of CBDCs are vast. Currently, during the transaction gap, currencies fluctuate, and money can be lost. For large, cross-border orders, companies will often pay a fee to take out a derivative or financial product to protect themselves against the currency change, hedging against the potential shortfall. So not only are they paying for a broker, but they’re also shelling out for a product to protect themselves from the exchange gap.      

If the result of Project Dunbar is that a new central bank cryptocurrency system is launched, an elite group of companies that provide clearing services will be out of business, but all companies looking to trade internationally will benefit from the disintermediation as every transaction will be cheaper, quicker, and entirely transparent. With a protectionist outlook prevailing in the current climate, cryptos could be the key to unlocking some of the existing barriers curtailing international trade.

Central banks have little choice but to retaliate against cryptos - they don’t want to be disintermediated from the financial system. Central banks want people to use a currency that they can control because, by extension, they need to be able to control the economy alongside their respective national governments. If they can bring the advantages of Bitcoin to a real digital currency backed by them, there’ll be less reason for individuals to use a cryptocurrency. This will impact on the value of cryptos, making them even more volatile as an investment, allowing central banks to stay in control. The fight back has begun; an international trade revolution could be on the cards and the volatile path of cryptos may be about to intensify.   

 

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QUIZ QUESTION: Which currency is the easiest to counterfeit?
LAST WEEK'S ANSWER:  Between April 2020 and April 2021 Elon Musk made $383,000,000 per day on average.
 
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The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.

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