With the rise of the modern information technology revolution, the impact of technology on finance and currency is unprecedented. As a new form of virtual assets and financial tools, digital currency emerges from time to time and continues to change and evolve, with increasing influence. On April 14, 2021, Coinbase, the world’s largest digital currency trading platform, landed on Nasdaq, with an IPO market value of approximately 65.3 billion U.S. dollars. It has become the most downloaded APP in North America. Affected by this, the price of Bitcoin has repeatedly hit new highs, which has aroused public attention and a lot of debate in the industry. In response to this, we tracked and analyzed the latest pattern of digital currency, focused on the main risks and the impact on my country, and put forward preliminary countermeasures.
The latest situation of digital currency
International organizations generally divide digital currencies into legal digital currencies (also known as “sovereign digital currencies”), private digital currencies (also known as “encrypted assets”), and both sovereign and non-sovereign characteristics based on different currency issuance and management methods. There are three types of stable digital currencies (“stable currencies” that anchor sovereign currencies or valuable assets).
(1) Private digital currency
Private digital currency refers to the “currency” issued by private organizations, without government credit endorsement, and encrypted with blockchain technology. Although it is called “currency” in name, it is essentially a non-monetary asset, and it is generally called “encrypted asset” in the world. Bitcoin, which was born in January 2009, is the first private digital currency. At present, there are about 7,000 different private digital currencies in the world, with a total market value of hundreds of billions of dollars. Due to the large price fluctuations, low transaction efficiency, and poor value recognition of private digital currencies, it is difficult to be used as a transaction currency, and it is mainly used for speculative and hedging investments. Recently, the first digital currency trading platform (Coinbase) was listed on the Nasdaq and the first Bitcoin financial product (ETF) entered the Toronto Stock Exchange, becoming a milestone event in the history of Bitcoin development. At the same time, under the “carrying of goods” by public figures such as Musk, the price of Bitcoin has continued to rise. As of the end of April 2021, the maximum unit price of Bitcoin is close to 65,000 US dollars, and the price has increased by more than 60,000 times in ten years. On the other hand, the lack of liquidity has caused the currency price to fluctuate sharply. In 2021, the cumulative liquidation amount of Bitcoin contracts reached hundreds of billions of dollars, involving millions of users.
(2) Stable currency
In order to overcome the risk of severe price fluctuations in private digital currencies such as Bitcoin, stable currencies that anchor sovereign currencies or real assets and maintain a fixed exchange ratio came into being. At present, there are about 50 kinds of stablecoins in the world, 23 of which have been traded, with a total market value of about tens of billions of dollars, and the rest are still under development and testing. Among the stablecoins in operation, USDT (USDT), which is anchored to the U.S. dollar, appeared the earliest (November 2014) and is currently the stablecoin with the largest market share. At this stage, the main purpose of stablecoins is to act as a trading intermediary between private digital currencies and sovereign currencies, facilitating the circulation of private digital currencies. In the future, stablecoins may achieve the main purpose of trading and become an important channel for cross-border transactions and payments. The Facebook “Libra” currently under development and testing has temporarily abandoned the goal of “super-sovereign currency” and transformed into “Diem” under strong financial supervision, but its design concept has a profound impact on the subsequent development of stablecoins .
(3) Legal digital currency
The rapid growth of Bitcoin and the emergence of “super-sovereign currencies” continue to challenge the status of traditional sovereign currencies, forcing central banks to carefully assess the risk of paper currency being replaced and to consider the feasibility of issuing digital currencies. Legal digital currency is issued by the central bank and endorsed by credit, which is equivalent to paper money. It is a payment tool with value scale and legal compensation. The legal digital currency originated from the report “Payment Technology Innovation and the Rise of Digital Currency” published by the Bank of England in 2014 . The Bank of England immediately launched the “Digital Pound Plan”, which initiated the largest reform of the sovereign currency system in the history. In the fourth quarter of 2020, the Bank for International Settlements (BIS) issued a questionnaire to 65 central banks around the world. 86% of central banks stated that they are conducting research or experiments on central bank digital currencies (CBDC) , legal digital currencies have already caused Central banks around the world are paying great attention. At the end of 2020, my country began to carry out the trial use of legal digital currency (DC/EP) in Beijing, Shenzhen, Suzhou and other places, becoming the first country to issue and test legal digital currency among the world’s large economies.
The main risks caused
(1) Risks caused by private digital currencies
Private digital currencies have the characteristics of anonymity of transactions, free flow of funds across borders, and irreversible transactions. Because of their free supervision, their risks follow the “roller coaster” of currency, and the potential risks to market participants and the entire financial system are constantly increasing. accumulation. First, encrypted assets are prone to risk of money laundering and terrorist financing. In the encrypted asset system, both service providers and users are anonymous, and the obscure transaction chain makes it easy for criminals to conceal the source and direction of their funds, which facilitates money laundering, terrorist financing, and evasion of sanctions. The second is the lack of transparency in the encrypted asset system and the lack of supervision, which brings consumers multiple risks such as legal transaction risk, fund settlement risk, price fluctuation risk, technical vulnerability risk, and fund-raising fraud risk. Third, with the improvement of technology and the expansion of the scope and scale of the use of encrypted assets, encrypted assets have replaced cash, bank deposits and non-bank payment instruments to a certain extent, and the probability of a single encrypted asset system risk evolving into a systemic risk is rising. .
(2) Risks caused by stablecoins
Stable currency has important value in maintaining currency stability and facilitating cross-border transactions. It also has the potential to grow into a “super-sovereign currency”. However, it is in financial stability, regulatory compliance, technical security, privacy protection, cross-border money laundering, and many other aspects. There are many challenges in this regard. First, stablecoins that lack supervision are difficult to abide by the promise of fixed exchange ratios, and scandals of stablecoins over-issuing and operating the market have repeatedly occurred; second, stablecoins challenge the current cross-border payment regulatory system. The main cost of cross-border payment comes from the differences in the regulatory systems of various countries, but new technologies and new payment tools just bypass rather than fundamentally solve this problem; third, stablecoins change digital asset verification and transaction methods, and circumvent current data Supervision methods and rules, in particular, will greatly change data supervision methods and rules, and bring new challenges to data flow supervision; fourth, it may encourage terrorist financing and give birth to new channels for cross-border money laundering. Stablecoins with communication tools can realize the transfer of funds around the world “as easily as sending text messages or sharing photos”. This is undoubtedly a “nightmare” for cross-border capital flow supervision.
(3) Potential risks of legal digital currency
Although compared with private electronic payment methods, legal digital currency has the advantages of universal availability, no transaction intermediary fees, and it helps to improve the effectiveness of monetary policy and combat illegal and criminal activities. The actual application of currency is very cautious. According to a research report on retail central bank digital currencies released by the International Monetary Fund (IMF) in June 2020, legal digital currencies may cause the following potential risks:
First, the introduction of legal digital currency may affect the transmission of monetary policy. For example, legal digital currency may change the demand for base currency and its composition in an unpredictable way, and may also change the sensitivity of currency demand to changes in interest rates.
The second is to affect financial stability and commercial bank operations. Banks with a larger share of deposits will face competition from legal digital currencies, especially interest-bearing legal digital currencies, so banks must raise interest rates to attract deposits or turn to wholesale funds. This will reduce the overall net interest margin of commercial banks, leading to higher loan interest rates and increasing bank operational risks. The instability of bank funds will force banks to hold more liquid assets or reduce lending.
The third is to have an impact on the central bank’s balance sheet. If financial disintermediation occurs, the deposits of commercial banks will be lost to the central bank, which can lend this part of the funds to commercial banks so that commercial banks can continue to engage in lending business. This will significantly deviate from the traditional responsibilities of the central bank. The central bank will decide how to allocate funds and open the door for policy intervention.
Fourth, legal digital currencies that are readily available, safer and more liquid than bank deposits may accelerate bank runs, but this depends on whether there is a deposit insurance system and the type of crisis.
Fifth, legal digital currencies that can be used as reserve currencies in cross-border transactions may intensify currency substitution in countries with high inflation rates and high exchange rate fluctuations.
The main challenge to our country
Digital currency is a new form of currency in the era of digital economy. It is the product of highly developed modern commodity economy and the continuous advancement of cryptography technology. It also represents the development direction of modern credit currency forms. It has promoted the innovative application of my country’s blockchain technology to a certain extent. And development has also led to the development and utilization of idle energy in remote areas of our country. However, with the skyrocketing currency prices, cross-border financial activities and coin mining activities under the banner of “digital currency” are having a certain impact on my country’s financial markets, currency markets, and even energy and commodity markets.
On the one hand, domestic companies set up websites overseas to provide financial services in violation of laws and regulations on the return journey. For example, conducting foreign exchange margin transactions in China through overseas platforms or conducting ICO transactions in China, completing cross-border transfers of funds or money laundering through the buying and selling of digital currencies, and conducting cross-border gambling, cross-border real estate speculation, stock speculation through digital platforms or applications, etc. my country’s financial market order. Some domestic institutions conduct cross-border “grey and black” financial services through websites established in China. Currently, they are mainly concentrated in the traditional Internet finance field. For example, through traditional fraud and misleading means and methods, promise high profits, cover up the transaction process, use the MLM model to develop customers, conduct MLM fraud overseas under the banner of my country, and damage the national image of our country.
On the other hand, the high currency price has caused a large amount of my country’s resources to flow into the “mining” industry, which may harm the fulfillment of my country’s “carbon peak” and “carbon neutral” goals. Although many countries support the “minting” of clean energy, with the skyrocketing price of digital currencies, more and more fossil energy is used to generate electricity to support “mining.” According to a study published by the Cambridge Centre for Alternative Finance (CCAF), Bitcoin-related electricity consumption reached a record high in 2020, and the global mining industry used more than 7 gigawatts (7GW) of electricity. Electricity (approximately 63.32 TWh), which is roughly equivalent to the power of 7 nuclear power plants or 21.8 million solar panels. Among them, China bears 65.08% of energy consumption, followed by the United States (7.24%) in second place, and Russia (6.90%) in third place . Research by a team of experts from the Chinese Academy of Sciences and the Department of Earth Sciences of Tsinghua University also found that without any intervention, the energy consumption of the Bitcoin blockchain in China is expected to reach its peak in 2024, about 296.59 terawatts. At that time, that is to say, in China alone by 2024, the electricity consumed by Bitcoin mining in a year will reach nearly 300 billion kWh. This will produce 1305.0 million tons of carbon emissions . While mining causes energy shortages, it poses a huge threat to my country’s “carbon peak” and “carbon neutral” goals, and we must pay attention to it as soon as possible. At the same time, the computing power and hardware resources required for mining continue to be tight, which has had a considerable impact on the normal consumer demand of the market.
Coping with suggestions
In general, in the face of many challenges such as monetary sovereignty, financial stability, regulatory compliance, technical security, privacy protection, and cross-border money laundering, it is still unknown whether non-sovereign digital currencies can “stable and achieve long-term stability”. At present, in order to prevent the impact of the sharp rise and fall of currency prices, ensure the overall security of my country’s financial system, and prevent risks and seek stability is still a top priority. It is recommended that my country adhere to the work tone of “seeking progress while maintaining stability” and “concentrating efforts to do its own business”, vigorously promote the research and development and application of my country’s sovereign digital currency, and simultaneously respond to the following risks:
One is to address the potential risks of private digital currencies. Considering that its application prospects and trends are not yet clear, it is recommended to closely follow the latest developments, do a good job in risk research and prediction, reserve risk response technologies and plans in advance, and actively explore the inclusion of private digital currencies such as Bitcoin in my country’s foreign exchange asset reserves.
The second is to address the potential risks of stablecoins. At present, major developed countries and international organizations are gradually tightening supervision. It is recommended that my country closely follow the changes in foreign regulatory attitudes, strengthen innovative exploration and risk assessment of the new concept and new structure of stablecoins, and at the same time actively connect with supervision and do a good job in compliance development.
The third is to test applications for sovereign digital currencies. It is recommended to learn from the useful experience of Internet financial risk prevention, and the relevant regulatory authorities should cooperate closely to prevent and control related risks, provide technical support for cracking down on illegal behaviors of digital RMB and blockchain, and ensure the stability of the financial and monetary system.
Fourth, in response to specific cross-border violations, it is recommended that in accordance with the State Council’s anti-money laundering, anti-terrorist financing, and anti-tax evasion supervision system and mechanism, the transfer of clues and the investigation of cases should be strengthened to form a joint force in the fight against crime. It is recommended to include digital currency and blockchain risk response plans in my country’s “Carbon Peak” in 2030 and 2060 “Carbon Neutrality” roadmaps to ensure the smooth realization of related goals.
Fifth, in response to the risk and challenge caused by non-clean energy “mining”, it is recommended to include digital currency and blockchain risk response plans in my country’s carbon peak in 2030 and carbon neutrality roadmap in 2060 to ensure the smooth realization of related goals.
Author/ Translator: Jamie Kim
Bio: Jamie Kim is a technology journalist. Raised in Hong Kong and always vocal at heart. She aims to share her expertise with the readers at blockreview.net. Kim is a Bitcoin maximalist who believes with unwavering conviction that Bitcoin is the only cryptocurrency – in fact, currency – worth caring about.