Governments and central banks have crucial role to play in digital finance innovations

Digital finance innovations, such as cryptocurrencies and central bank-backed digital currencies, can boost financial inclusion and improve cross-border payments, but regulators need to enact global standards to keep the associated risks in check, according to industry experts.

The International Monetary Fund said it is looking at both the risks and opportunities that digital currencies pose.

“We can have [digital] currencies used for international exchange moving much faster and allowing for a different capital flow management … hopefully in a way that benefits the global economy,” the Washington-based lender’s managing director Kristalina Georgieva told an online panel during the IMF's Digital Money Revolution seminar on Friday.

Central banks across the world are increasingly assessing the potential of digital currencies amid a growing interest in cryptocurrencies and other online payment channels.

The number of countries developing central bank-backed digital currencies (CBDCs) has dramatically increased as consumers shifted to digital payments during the coronavirus pandemic, a report by Moody’s Investors Service said. In a separate report in May, Fitch Ratings said that the use of CBDCs could help boost financial inclusion and stability while helping to speed up cashless payments.

If used responsibly, digital assets can result in a “multipolar international monetary system that is safe and more resilient”. But there could be some “troubling developments” such as a surge in cyber attack incidents and currency substitution on a much bigger scale, Ms Georgieva said.

Currency substitution is the use of a foreign currency in parallel to or instead of the domestic currency. It can be full or partial.

“The currency substitution may accelerate and then countries may lose control over their monetary policies,” Ms Georgieva said.

“We found that 110 countries already have some engagement on this topic. From just exploring what it is to Bahamas that issued its own Sand Dollar.”

The Bahamas' central bank digital currency, known as the Sand Dollar, went live in October last year.

Cryptocurrencies are usually vulnerable to cyber attacks and wild swings in value that can create financial instability. Users are required to disclose only limited amounts of information, while high levels of anonymity could enable money laundering and terror financing, the fund said in a recent report.

“[The] crypto world is booming, stablecoins are knocking at the door, decentralised finance is on a faster growth path … so you might wonder why central banks want to join that party when it is already happening without us,” Benoît Cœuré, head of the Bank of International Settlements’ Innovation Hub, told the panel.

"Central banks do have a mandate – they have a responsibility towards the society which is about the monetised ability and good financial stability … we want to make sure that we deliver on it in the world that is digital and is changing very fast,” he added.

Digital currencies can be a boon for groups that are still unbanked or underbanked, industry experts say. Globally, about 1.7 billion adults remain unbanked with no account at a financial institution or through a mobile money provider, a 2017 World Bank report said.

“This [digital currency] technology has transformative potential to bring more people into the [mainstream] financial system … giving businesses and consumers better access to low-cost digital payments,” Eswar Prasad, a professor of economics at Cornell University and a senior fellow at Brookings Institution, told the panel.

“But all these benefits come with some cautionary notes attached. The government has to play an important role in setting up guard rails to make sure there is no negative financial stability implications,” said Mr Prasad, who recently authored a book, The Future of Money: How the Digital Revolution is Transforming Currencies and Finance, which looks at how accelerating financial change will transform economies.

Central banks around the world have been reluctant to endorse cryptocurrencies due to their speculative nature, lack of value and regulatory oversight.

The Central Bank of the UAE does not recognise cryptocurrencies as legal tender.

Last month, China, the world’s second-largest economy, vowed to root out “illegal” activity in the trading of Bitcoin and other virtual currencies, as it renewed its tough talk on cryptocurrencies.