How digital currency will reshape international finance

Digital money is an important part of the digital society. Various forms of electronic payment have replaced traditional paper money, and electronic wallet has replaced traditional wallet. In recent years, the International Monetary Fund, the Bank for International Settlements and other institutions have paid considerable attention to the impact of digital currency on international economic, trade, finance and other fields. A major consensus of the international community is that digital currency has entered a new era. It will gradually replace the US dollar and the euro, promote cross-border commerce and trade, and realize the spatial and temporal transfer of wealth and resources. The new transformation of digital currency replacing traditional currency may reshape the banking, financial industry and even social structure.
What are the advantages
For most of human history, traditional currencies such as shells, metals and paper money have been playing the role of payment and storage. With the popularity of digital technology, the way people communicate in time and space has changed, and more and more business transactions have turned to online, which means that the era of traditional currency may end, even in low-income and middle-income countries. The era of digital currency has begun, and is now at the forefront of economic and social change. A new round of digital competition between legal tender and private currency is also looming on the domestic and international stage. The transformation and diffusion of digital currency can promote innovation and expand access to basic financial services. However, these digital currencies may aggravate the concentration of economic power and allow large companies and governments to "invade" more inclusive finance and private life.
Traditional financial institutions, especially commercial banks, are facing the challenge of business models, because new technologies have spawned online banks that can cover more customers, and web-based platforms that can directly connect depositors and borrowers. These new institutions and platforms are intensifying competition, promoting innovation and reducing costs. Savers are getting a wider range of savings, credit and insurance products. Banks often have strict requirements for loan underwriting and collateral, while small-scale enterprises can obtain financing from other sources than banks. Domestic and international payments have become cheaper and faster, benefiting consumers and enterprises.
Role of central bank
Bitcoin and other cryptocurrencies do not rely on central bank funds or trusted intermediaries such as commercial banks and credit card companies for transactions, thus reducing the inefficiency and additional costs of these intermediaries, which may change the payment method. However, the price fluctuation of cryptocurrency, as well as the restrictions on transaction volume and processing time, make cryptocurrency ineffective as an exchange medium. Most of the new cryptocurrencies known as stable currencies gain stable value through the support of central bank money and government securities. They have received more attention as payment means. Blockchain technology promotes the rise of new digital assets such as cryptocurrency through the security ownership of pure digital objects. The blockchain technology supporting cryptocurrency is catalyzing profound changes in currency and finance, which will affect households, enterprises, investors, central banks and governments in a profound way.
At the same time, if the decentralized payment system or private stable currency replaces the cash and traditional payment system managed by the regulated financial institutions, the central bank will inevitably worry about the impact of cryptocurrency on financial and economic stability. The payment infrastructure fully in the hands of the private sector may be both efficient and cheap, but if confidence is lost during the financial turmoil, some of the payment systems may be frozen, and if there is no effective payment system, the modern economy will come to a standstill.
In response to these concerns, the central bank issued digital central bank currency (CBDC) for retail payment. The advantages of the central bank's digital currency are as follows: First, expand financial inclusion, and people without bank accounts can easily access the free digital payment system; Second, create public payment options similar to cash to improve the efficiency and stability of the payment system; Third, to prevent illegal activities such as drugs, money laundering and terrorist financing that rely on anonymous cash transactions, and to regularize more shadow economic activities, thus making tax evasion more difficult; Fourth, small enterprises will benefit from lower transaction costs and avoid the trouble and risk of handling cash.
Of course, the digital currency of the central bank also has shortcomings: First, the digital currency of the central bank brings risks to the banking system. Commercial banks are crucial for creating and distributing credit to maintain the smooth operation of the economy. If household savings are transferred from ordinary bank accounts to the central bank's digital wallet, even if no interest is paid, depositors will think it is safer. If commercial banks lack deposits, the central bank may find itself at a disadvantage and have to take over credit allocation and decide which departments and enterprises should get loans. In addition, the central bank's retail payment system even suppresses the private sector in order to make digital payment cheaper and faster.
Second, the central bank's digital currency may leak personal privacy. Even if there are protective measures to ensure confidentiality, any central bank wants to keep verifiable transaction records to ensure that its digital currency is only used for legitimate purposes. Therefore, there is a risk that the central bank's digital currency will eventually destroy the anonymity and privacy traces in commercial transactions. However, the digital currency of the central bank can reduce many of its risks through careful design with the rapid development of technological innovation.
Third, the central bank's digital currency makes it more difficult for the central bank to perform its macro-control function. The central bank maintains low unemployment and inflation by manipulating interest rates. When the central bank changes its key interest rates, it affects the deposit and loan rates of commercial banks in a way that is quite easy to understand. However, if the popularity of digital lending platform weakens the intermediary role of commercial banks between depositors and borrowers, it is not clear how or whether the transmission mechanism of digital monetary policy will continue to play a role.
Fourth, the central bank's digital currency faces new competition. Legal tender is a unit of account, medium of exchange and means of value storage. A century ago, private currencies competed with each other and with legal tender issued by the government. The emergence of the central bank has decisively changed the balance and is beneficial to legal tender. In the digital era, the basic functions of the central bank in issuing money have changed. Various forms of digital currency and the technology behind them make it possible to separate the function of currency and compete directly with legal tender. The private intermediary payment system is becoming more and more important, intensifying the competition between various forms of private currency and legal tender of the central bank as the medium of exchange. If market forces are allowed to act on their own, some currency issuers and payment technology providers may occupy a dominant position and even affect the nature of currency and its role in the economy.
Pattern reshaping
In the digital era, the new form of digital currency and the new channel of cross-border transfer of funds will reshape the structure of international capital flows, exchange rates and the international monetary system, which will bring great benefits as well as new challenges.
On the one hand, international financial transactions will become faster, cheaper and more transparent. This will be beneficial to investors seeking diversified portfolios, enterprises hoping to raise funds in the global capital market and economic immigrants who will remit the funds back to their home countries. Faster and cheaper cross-border payments will also promote international trade, which is particularly beneficial to emerging market countries and developing economies with high export dependence.
On the other hand, the emergence of new channels for cross-border flows not only promotes international trade, but also facilitates the flow of illegal funds, bringing new challenges to financial regulators. It is more difficult for the government to control the cross-border flow of legal investment capital, and emerging economies are more vulnerable to the impact of the monetary policy measures of the world's major central banks, which may lead to capital outflows, and then suffer from cyclical economic crises.
In the next few years, central banks and governments around the world will face an important choice: to resist new financial technologies, passively accept financial innovation led by the private sector, or accept the potential efficiency benefits provided by new technologies. The emergence of cryptocurrency and the prospect of the central bank's digital currency are related to the role that the government should play in the financial market, maintain the flexibility of the private sector, and make up for market failures, especially the large number of households without bank accounts in developing economies and even in developed economies such as the United States.
The recent market volatility of cryptocurrency shows that the regulation of the digital currency industry is crucial to maintain the integrity of the payment system and financial market, fully protect investors and promote financial stability. Given that the retail, wholesale and cross-border businesses of the financial industry require more efficient payment services, financial innovation led by the private sector can bring huge benefits to households and enterprises. The main challenge faced by the central bank and financial regulators is how to balance financial innovation, investors' potential risks and the overall stability of the financial industry.
The new financial technology is expected to make it easier for poor families to obtain a series of financial products and services, thus realizing the melting of inclusive funds. However, technological innovation in the financial sector, even those that may allow more effective financial intermediation, may have a dual impact on income and wealth inequality.
At the domestic level, the benefits of financial technology innovation are mainly obtained by the rich. They can use financial technology innovation to increase financial returns and diversify risks. Existing financial institutions can make interest preference choices. On the contrary, vulnerable groups with limited digital access and lack of financial knowledge cannot fully understand investment opportunities or bear investment risks. Therefore, the impact of digital currency on income and wealth inequality has risen sharply in some countries and may cause political and social instability.
At the international level, there will be greater stratification and gap between countries in digital currency and digital innovation. Smaller economies and economies with weak financial institutions have their central banks and currencies squeezed or even wiped out, and more economic and financial power is concentrated in large economies. At the same time, large multinational technology enterprises can gain more control by controlling commercial and financial channels.
In the new era of digital currency, the government can play an important role in clarifying property rights, protecting investors' rights and ensuring financial stability. The innovation of cryptocurrency and financial products should be based on the supervision and trust of the government. The government has the responsibility to promote fair competition by legal means and concrete measures, instead of favoring the old enterprises and allowing the large enterprises to stifle the smaller competitors.
Bitcoin and other cryptocurrencies are designed to ensure anonymity and eliminate dependence on the government and major financial institutions in business activities. If market participants and regulators believe in technology excessively, financial innovation will generate new unknown risks. Decentralization or fragmentation of digital currency can produce efficiency when the economy is booming, but it will quickly destroy stability when the economy is in trouble. Replacing cash with digital payment systems can eliminate the traces of privacy in business transactions and promote changes that may ultimately damage privacy. With personal privacy facing greater risks, government power will be difficult to contain, and potential major changes in social structure are coming.