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Central Bank Digital Currencies Can Disrupt, Bring More Stable Financial System: EU Report

Last Updated March 4, 2021 5:09 PM
Andy Peterson
Last Updated March 4, 2021 5:09 PM

“When the crypto gold rush ends, in which most people buy and sell cryptocurrencies solely to strive for profit, then fluctuations are likely to abate and the actual use case for cryptocurrencies as money may gain momentum”

A report, requested by the European Parliament’s Committee on Economic and Monetary Affairs, assessed cryptocurrencies, regulations, ICO’s and the possible effect of introducing central bank digital currencies (CBDC) on the financial system. The study was authored by several members of the Kiel Institute of the World Economy who provide in-house counsel to the European Parliament committees.

On Cryptocurrencies

The report  defined cryptocurrencies as a “special case of virtual or digital currencies” with “absence of a central counter-party, non-discriminatory public access, and security against fraudulent spending.” as their key characteristic features.
Bitcoin and other cryptocurrencies have been determined as problematic to use a medium of exchange given their volatility. However, the report stated that this might change in the future once the speculative phase passes.

“High volatility is explained by the lack of trading pairs, low trading volumes, and strong volatility of demand, and is currently an inherent aspect of almost every single cryptocurrency.“ the report mentioned. “Volatility of individual cryptocurrencies could decrease in the future as Bitcoin dominance declines, but this is uncertain due to the speculative nature of cryptocurrency demand.”.

The report talks about the design and functionality of bitcoin and it’s consensus algorithm. It expresses concerns over the massive resource consumption and restricted scalability. Proof of Stake is mentioned as a possible way to overcome the limitations faced by Proof of Work algorithm.

“As of yet, it is unclear whether such a system could rise to prominence and whether it would introduce its own pathologies.” the report stated on PoS.

Monero, Dash, and ZCash are also mentioned for their ability to allow for private transactions as opposed to bitcoin where all the transactions are publicly visible on the shared ledger. It also further states that “These technological improvements over Bitcoin are therefore necessary to replicate one of the main features of common cash: the ability to conduct uncensored, private transactions.”

Lightning Network is noted to be a possible solution to tackle the issue of low transaction speeds. However, the report also stated, “Since technological innovations such as these are still very young and the development process is ongoing, a final assessment cannot yet be made.”

Cryptocurrencies have been deemed to have a cost advantage over transitional currencies when used for global money transfers and they have also been termed to be useful for citizens in countries with strict capital controls and cash shortages.

“Cryptocurrencies could serve as a vehicle to protect assets against theft or repressive confiscation, increase systemic competition, and eventually financial stability, but current technology is a limiting factor.”

ICO’s and Regulations

“Further clarification by European authorities concerning the laws and regulations applicable to different types of ICOs could be helpful.”

While the report states that ICO’s may provide useful information about customers valuation of products to companies, it believes that ICO’s are used to avoid high regulatory costs associated with traditional fundraising. It claims that recent flood of ICO’s have highly questionable proposals and “the majority of white papers does not provide enough financial information for a well-founded investment decision, and none of them used an external auditor to certify the information.”.

The report called for lawmakers and regulators to take into account the diversity of the kinds of ICO’s while regulating this new phenomenon. It states that it is important to ensure that businesses associated with cryptocurrencies do no to put the financial sector at risk. It also mentioned the need to regulate the trading of cryptocurrency exchanges where practices that have been banned in the traditional financial system, like wash and insider trading, still exist.

“However, regulatory action against fraud and manipulation is complicated by the progressive development of decentralized exchanges.” the report opined.

Central Bank Digital Currencies

The report mentioned that issuance of a Central Bank issued digital issue could have disruptive effects. Having a CBDC is stated to allow citizens to hold their money in a digital form as opposed to having to deposit them in banking institutions.

“With a central bank digital currency (CBDC), the broader public could be granted access to non-tangible central bank money.” the report added. “A digital currency issued by the central bank could substitute bank deposits as the main form of money holding”.

This move would entail major changes to the financial system causing commercial banks to come up with more reliable funding sources to replace deposits. Thus forcing banks to innovate come up with an alternative to the current reserve system.

“CBDC is not necessarily a bad development, but instead could finally pave the way for a more stable financial system.” the report concluded.

Earlier this year, the vice president of the European Commission called on EU nations to focus on blockchain technology alongside Artificial Technology. Similarly, the European Commission announced to establish an EU Blockchain Observatory aimed to work towards using this technology to help the EU in governance, infrastructure, legal and regulatory challenges etc.

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