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As contact-free payments increased explosively due to the COVID-19 pandemic, the development of central bank digital currency (CBDC) in each country is accelerating. The demand for CBDC is growing because it is simpler and safer than the existing online payment system that has to go through a rather complicated process. At the same time, the competition for digital currency hegemony triggered by China is also the reason why CBDC cannot be delayed any longer.

 

 

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China aims to use digital yuan at 2022 Winter Olympics

 

China is speeding up the commercialization of digital yuan for the Beijing 2022 Olympics. They are showing their ambition to gain an edge in the digital currency hegemonic competition by allowing people from all over the world gathered at the Olympics to use their own digital currency.

Korea has also recently selected Ground X, the blockchain subsidiary of Korea’s largest mobile platform, Kakao, as a CBDC test company to accelerate the development of CBDC.

 

What is CBDC?

The biggest difference between virtual assets such as Bitcoin, Ethereum and CBDC is the issuing entity. While anyone can issue virtual assets, CBDCs are issued by the central bank just like fiat currency. In fact, it is a centralized digital currency that runs counter to the virtual assets that are advocated for decentralization.

 

 

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Since both virtual assets and CBDCs are created based on blockchain technology, counterfeiting and tampering are impossible, and quick and easy transactions can be made. However, while virtual assets have high volatility depending on market conditions, CBDCs are much more stable as they have a one-to-one value with fiat currency like a stablecoin linked to the real value.

 

How will CBDCs affect banks?

CBDC is like another type of currency being issued in addition to the existing fiat currency. Accordingly, banks are judging that it will be distributed through banks.

Banks are judging that the status of the bank, which is being shaken by the explosive growth of fintech companies in CBDC, has had an opportunity to turn around. If CBDC becomes popular and overwhelms the use of simple payment by fintech companies, the status of banks in the payment market will inevitably increase.

In fact, in the CBDC external research service report published by the Bank of Korea, the ‘mixed type’ was mentioned as a promising distribution method for CBDCs, in which the BOK is in charge of issuance and financial institutions such as banks that are permitted to transact under the BOK Act are in charge of services including supply and collection.

 

In addition, the report analyzed that Article 79 of the Bank of Korea Act (Restrictions on transactions between the Bank of Korea and the private sector other than financial institutions) may need to be revised according to a series of transactions such as deposits and loans with the BOK if fintech companies participate as a CBDC distribution institution. 

 

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The Bank of Korea selected Ground X, a subsidiary of Kakao, as a CBDC test company

 

However, along with expectations for future growth engines, there are also concerns about CBDCs called ‘digital bank run’. The report on ‘Status of Implementation of CBDC in Major Countries’ published by the International Financial Center stated, “If CBDC is regarded as an alternative to bank deposits, concerns are raised that it may lead to de-financial intermediation of banks and digital bank runs.”

A ‘bank run’ refers to a large-scale withdrawal of deposits through bank tellers or ATMs. “Digital bank run” refers to contact-free means such as online or mobile. As it is non-face-to-face, it is difficult to immediately respond because the fluctuations of depositors are not visually captured. The characteristic of Digital Bank Run is that it proceeds quickly but quietly.

Therefore, if the demand for CBDC rises, bank deposits will be replaced with it, which could significantly reduce the deposit balance. In the end, the expansion of the bank's financing costs and the decrease in its lending capacity may lead to a weakening of the bank's intermediary function.

 

Are domestic banks preparing for CBDCs?

The banking sector is taking a pre-emptive response, judging that CBDC will be the core business that will survive in competition with fintech companies in the future.

 

Shinhan Bank and LG CNS have completed the pilot construction of a blockchain-based digital currency platform, and Hana Bank conducted CBDC technology verification with POSTECH Center for Cryptocurrency & Blockchain Research (CCBR).

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Shinhan Bank is the fastest domestic bank responding to CBDC

 

Woori Bank also plans to launch a full-fledged business by releasing a request for proposal (RFP) for a blockchain platform. KB Kookmin Bank plans to actively conduct pilot tests related to technology verification and electronic wallet implementation according to the Bank of Korea's CBDC design results.

 

 

Can virtual asset exchanges handle CBDC?

Contrary to the accelerating response of banks to CBDCs, virtual asset exchanges have relatively few actions toward CBDCs. In the meantime, an interesting article appeared about the possibility of listing CBDCs on virtual asset exchanges.

Brian Armstrong, the CEO of Coinbase, the largest virtual asset exchange in the United States, said in a Reddit in March that CBDC will be listed on Coinbase's listing criteria if it meets the listing requirements.

 

He said this under the premise that it is an important trend and that the market will grow. Like its own stablecoins such as USDC and DAI, it can be sufficiently handled on virtual asset exchanges.

 

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Concerns about the disappearance of virtual assets due to CBDC and opinions that it will further develop through synergy are conflicting.

However, most experts expect the emergence of it has a positive effect on virtual assets.

 

However, it seems unlikely that it will be listed on virtual asset exchanges unless governments change their perception of it as an antithesis of virtual assets.

Federal Reserve Chairman Jerome Powell predicted that the digital dollar would eliminate the need for virtual assets, and the Bank of Korea also believes that CBDCs will replace existing virtual assets. In other words, both central banks in the United States and Korea consider it as a substitute for virtual assets.

Nevertheless, many experts expect the emergence of it to be a boon for the exchanges.

If it replaces the role of money and traditional virtual assets focus on the function of a store of value, virtual assets may become fully established as ‘assets’.

 

In addition, if it is activated, the understanding of opening the wallet and digital currency will increase. This can lead to promoting the use of virtual asset exchanges by lowering psychological resistance to entry into the virtual asset market.

 

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» Countdown to CBDC institution, how will it affect banks? 2021.08.04