Central banks are preparing the reconfiguration of the architecture of the global monetary system

The Covid-19 lockdown and the associated economic crisis have irrevocably changed people's lives. One of the changes with a long term impact has been the acceleration of the transition towards digital payments: customers have avoided using cash due to the alleged risk of infection, and companies have sought to adapt by moving their activity online - in Romania, online trade has increased by almost 50% last year.

These challenges have provided a fertile field for exploring new digital forms of payment, according to an extensive research by the Davos Digital Currency Governance Consortium of the World Economic Forum (WEF), a study that seeks to weigh the benefits and risks associated with these new forms of currencies.

"How the world's states coordinate when it comes to the treatment of these new technologies, which are potentially disruptive, will critically shape the way the opportunities they present can be harnessed and the risks can be mitigated," the report published on May 4th by the WEF says.

Two such new technological developments in digital payments are the so-called "Central Bank Digital Currencies" (CBDC - digital coins issued by central banks) and "Stablecoins". Central banks are currently studying CBDCs as monetary authorities are facing various steps that jeopardize their own powers (Facebook's Libra project or the Diem stablecoin project) or projects of geostrategic interest (China's Central Bank project for a digital yuan), as well as an increasing demand for digital payment solutions.

Such a study conducted by the Bank of International Settlements (BIS), an institution informally called "the central bank of central banks", shows that over 85% of central banks are currently studying or testing CBDCs, digital currencies which it is unknown when they will be issued and used.

As an example, Singapore has recently concluded its so-called Ubin Project, a multi-annual research in using CDBC for major transactions, "in bulk", while is still conducting an advanced pilot project which is looking for the mass use of a digital yuan. The European Central Bank (ECB) and the Bank of England (BOE) have also recently begun their own research on the topic of CBDCs. Beyond the pilot projects, the islands of the Bahamas and the Monetary Union of Countries in the Western Caribbean (ECCB - Eastern Carribean Central Bank - the monetary authority of eight island-states in the Caribbean) have recently begun issuing this kind of digital currencies.

Unlike CBDCs, Stablecoins are not intended to be issued by monetary authorities, but rather by private entities. These are rather regarded as Cryptomocurrencies - they use the Blockchain technology - but the difference / benefit is that they have stabilization mechanisms that maintain their prices fixed in relation to a fiat currency. Thus, the obvious volatility in the existing cryptocurrencies, which turns them into better potential transfer currencies and gives them a more stable aspect of value storage. Two examples are TETHER and USD Coin, which are tied to the value of the US dollar.

According to WEF experts, one of the main benefits of CBDCs or Stablecoins is the potential to facilitate fast and cheaper cross-border transactions, which will reduce consumer costs, facilitate international trade and strengthen global economic integration.

• Report: "Digital coins could have been used to improve cash distribution during pandemic"

Research shows that the pandemic has highlighted the importance of improving access to digital financial services that will effectively help those in need.

"Digital coins could have been used to improve the distribution of unemployment benefits and support payments during the crisis, especially when moving or physical access were not possible. For example, in 2020, the Grameen Foundation successfully distributed financial support Covid-19 in the form of digital vouchers to 3,500 women in the Philippines, used for the purchase of food and medical packages, through an application on their mobile phones", according to the WEF study.

Also, another opportunity for digital currencies, both for public ones for private ones, is to encourage financial inclusion: "Digital currencies could reduce the barriers faced by low and difficult-to-reach populations (geographically) when it comes to access to financial services".

However, according to experts, further research is needed on the three mentioned opportunities, including the consideration of risks, compromises and added value compared to current options.

These technological developments are not devoid of significant challenges, the study shows, which points out that a payment system is a public good, which means it requires regulations.

"For example, decision-makers must come up with solutions for concerns that the digital currencies issued by private entities could be used outside regulatory perimeters, facilitating money laundering or terrorist financing transactions. The ease with which digital currencies can be purchased and traded and 24/7 through the Internet and a mobile phone, sometimes without the involvement of regulatory entities, raises concerns about consumer protection, data privacy and potential cyber security risks. (...) Fragmented regulations could provide vulnerabilities along jurisdictions, vulnerabilities that various actors could exploit. This could stifle the innovation of well-meaning actors that could end up being reluctant to experiment without a certified regulatory framework", according to the study.

On the macroeconomic level, CBDCs and stablecoins supported by major fiduciary coins, such as the US dollar, euro or pound sterling, could also present risks of monetary and financial stability, especially for more vulnerable and developing economies.

"Some countries could suffer sudden capital outflows or volatility of the exchange rate due to the access of residents to a CBDC issued by a major economy with strong economic fundamentals and low inflation - or due to access to a relatively stronger foreign currency. This, in turn, could disrupt bank loans and wipe out local liquidity in bank deposits", the authors of the study show.

• WEF: "Central banks and decision-makers need to design CBDCs and regulations that stimulate competition"

The Governance Consortium for Digital Currencies of the Davos Economic Forum has identified several areas of interest where solutions need to be identified and proposed, the first and most important being the problem of future cross-border digital currency flows.

The workgroup proposes reaching an international consensus on the classification of digital currencies so as to ensure the existence of "consistent and efficient cross-border regulations."

"The recommendations of the Financial Stability Board for approaching the regulatory challenges brought up by the global stablecoins could serve as a benchmark for the individual jurisdictions. Moreover, the cooperation between the regulatory authorities (...) could reduce the gaps and issues caused by the cross-border use of these currencies", the report further states.

Second of all, data privacy needs to be "primordial". Governments need to establish "adequate practices for the sharing, holding or purchasing of account data to ensure the security of users' data and the protection of privacy".

Thirdly, collaboration between the public and private sector is considered fundamental.

"The private sector can offer innovative products and services that support the authorities' efforts to encourage more innovative, inclusive and resilient payments. In turn, central banks and financial policy decision-makers should be careful not to exclude private firms but design CBDCs or regulations in a way that stimulates competition", according to experts.

Lastly, technical interoperability should not be neglected. The extent to which CBDC or Stablecoin arrangements can be connected to new or pre-existing systems, internally and / or cross-border, will influence both the value they provide to their users as well as the benefits of increased market competition".

Data privacy must be "primordial". However, interoperability may (...) contribute to a slower rhythm of innovation, because as suppliers comply with common data and software standards, privacy should be "primordial", the report states.

• Debates on the topic of the reconfiguration of the architecture of the international monetary financial system have become increased lately

The debates on the reconfiguration of the architecture of the international monetary and financial system have also multiplied, lately, amid the increase of the divergences and incongruity between the main economic blocks of the world. Worth mentioning are the projects for the implementation of stablecoins, launched by the International Monetary Fund, G7, the European Central Bank and the European Commission, with the aforementioned also being a result of Covid-19 lockdown, which has again brought the dysfunctions of the international financial-monetary architecture to the foreground.

In recent years, the share of the US dollar in total international reserves has increased to about 58% in 2020, although the share of US GDP in the world economy has seen a downward trend over the last decades, and US public debt has risen year after year, to record levels. The weight of the Euro in international reserves is about 10 times higher compared to that of the Yuan, although China's GDP has in 2019 surpassed that of the Eurozone expressed in US dollars. It is also worth mentioning that over the last few years we have witnessed the persistence of currency wars between the main economic blocks of the world, amid the implementation of unprecedented monetary policy measures to support the pace of economic growth.

It should be noted that authorities have had a non-interest approach to private cryptocurrencies until recently, since the appearance of Bitcoin, as they didn't want to interfere with the technology behind these new currencies, as they did not feel significant risks from that direction. It seems that everything has changed with the Libra project announced in 2019 by Facebook, a company that enjoys the confidence of 2.8 billion active users.

WEF experts conclude that in the not-so-distant future, decision makers will have to make critical decisions about the role of public and private institutions in digital payments and digital currencies, and coordination for problem solving will determine the degree to which the world will be able to materialize the benefits of digitization, one of the few beneficial developments from the pandemic.