Ideas to get your business on target

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Central Banks and the Distributed Ledger: Towards a Cashless Society”

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Torn & Cut One Dollar Note Floating Away in Small $ Pieces via photopin (license)

– It is undeniable: in this information age, cash is becoming more and more unfavorable to regulators. Indeed its alternative – the digital currency – has all the advantages that regulators want: real time settlement, little transaction cost, absence of counterfeit money and reliable traceability (which renders tax evasion and money laundering near impossible). However, a lack of suitable and practical technology has been holding central banks back from realising these benefits, and for the most part of the decade we have only seen private application of the digital currencies. It was not until the rise of the cryptocurrency (a subset of digital currency) that central banks really started to consider adopting an official government-backed digital currency – one that utilise the innovative model of distributed ledger

– A government backed digital currency that exists alongside the current legal tender is certainly plausible, though hurdles remain. When both the new currency and the incumbent are controlled by central banks, the volatility problem from speculation of digital currency could potentially be eliminated. This is because as the sole issuer of both currencies, central banks can guarantee exchange of one for the other would always be met (since they can create more of each kind). With the ‘exchange rate’ fixed between the cryptocurrencies and an existing hard currency, users can be more assured in gradually replacing their current tenders with digital alternative.

Operationally however there remain doubts as to how the idea can be practically applied to current banking systems. At the heart of the debate is the level of transparency such system(s) would be allowed. Cryptocurrencies’ key selling point over their digital siblings is in the public ledger model, where in irreversible public block chains allow for privacy (from anonymity), and arguably traceability. The ledger is distributed and validated within the community, and all copies are kept up-to-date at all time. In a government-backed version, it would mean ledger records of all money creation and extremely large value transactions will be decentralised to more than one or two nodes. Effectively each and every bank using the currency would get its own detailed (albeit anonymised) record of how much money others are sending and how much money the central banks are creating. From a government standpoint this might not be so favorable (ledgers such as those of UK’s CHAPS or US’ Fedwire are kept centralised).

Additionally, just as with previous mediums of exchange, cryptocurrencies carry their own risks of thefts and fraud. In the age of digitalisation 2.0, a virtual version of the everyday sterling note trades physical risks of pickpocketing and bank robbery for threats of mass online hacking and cyber-attacks. BitCoin users, for instance, still find themselves victims to the average daily online threats, even with the public-private key encryption. This is because the process only verifies encryption on the recipient side and not the sender – attackers who gained access to your digital accounts (wallets) can still put in a transfer request and send your money to their account. Therefore any digital currency initiative will need to guarantee the security and resilience of the system, in order to convince cash users to make the switch.

– So in the end how close are we to the cashless society? This remains to be seen, as replacing cash isn’t exactly a done-in-a-week task. As of March 2015, there are £63.5 billion worth of Sterling and $1.29 trillion in circulation. Hence, for the time being any new digital currency will mostly likely co-exist with traditional mediums, until the transformation of payment and other relevant system are ready. Though difficult, the movement towards digital will soon take hold for many central banks as we head further into the information age of finance.

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