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Cryptocurrencies have exploded in popularity, but many are also leveraged by bad actors and pose economic risks. As a result, governments worldwide are exploring the possibility of creating their own digital currencies.
Central bank digital currencies, or CBDCs, have emerged as a possible solution to boosting financial access and making money easier to transfer. Advocates say they can help lower costs and provide better services for consumers, but critics worry about privacy.
Cryptocurrencies
Cryptocurrencies are virtual currencies based on a decentralized network, called the blockchain. They use encryption algorithms to mint coins, which are stored in virtual wallets. These transactions are recorded on tamper-proof ledgers that are distributed across the network.
In contrast, traditional national currencies are backed by a government’s central bank and are regulated to ensure that people can make transactions at a reasonable cost. This system has many advantages, including a high level of trust and security, but also risks a single point of failure that could lead to financial crises.
The emergence of cryptos and their growing interlinkage with a regulated financial system has raised new concerns around privacy, operational, cybersecurity, and financial stability risks. These issues are attracting a lot of attention from policymakers.
As these technologies become more established, they may be used to fund criminal activities and even terror attacks. It is therefore important to ensure that cryptocurrencies are well regulated so they do not become a tool for these activities.
Digital money
Digital money (sometimes called e-cash or Internet money) is replacing physical currency, such as paper bills and coins, as technology advances. Unlike traditional currencies, which can be easily counterfeited or double-spent, digital money is secure because it is encrypted using cryptography and stored on blockchain networks.
Governments around the world are developing central bank digital currencies, or CBDCs, to provide faster, safer and cheaper payment solutions for people. They are aiming to replace cash and improve access to financial services for those who cannot afford to use banks.
While many governments have embraced the idea, experts say they need to be careful about what kind of digital money is being issued. Some are promoting private cryptocurrencies, such as Bitcoin, while others are trying to build CBDCs that leave the state more in control of people’s spending habits.
In the United States, the Federal Reserve is launching a CBDC pilot program. The bank is testing a network of payment providers to see how it works and how quickly transactions can be settled.
Stablecoins
Stablecoins are a type of cryptocurrency that is designed to offer the flexibility of digital assets with the price stability of fiat currencies. They can either be backed by a reserve asset such as a currency or commodity, or they may use algorithms to adjust their supply in order to maintain the value of their coins.
These types of stablecoins are popular with decentralized finance platforms, as well as crypto investors seeking a more secure way to hold their cryptocurrency investments. Many of them also use stablecoins to avoid paying transaction fees on crypto exchanges.
Despite being marketed as stable and predictable, the collapse of algorithmic stablecoin Terra shows that they are not immune to market volatility, which means that these coins need to be clearly regulated before they can become a risk to financial stability and payment systems. This requires that financial regulators clarify obligations and put in place consumer protections.
Regulation
A regulation is an official rule that governs conduct within a specific area. It is typically applied by a government agency.
The United States has made a series of efforts to regulate the cryptocurrency industry. These include increasing anti-money laundering (AML) and countering financial terrorism (CFT) requirements for digital currency exchanges.
However, those regulations have had minimal impact on international cybercrime. This is partly because crypto exchanges are easy to use and criminals can easily create new wallets and accounts whenever they are targeted by law enforcement.
President Biden’s March 9 executive order on digital assets outlined the first whole-of-government approach to addressing risks and harnessing potential benefits of digital assets and their underlying technology.
In addition to focusing on AML and CFT issues, the framework calls for an ongoing effort to enhance dialogue with private firms about their existing obligations and illicit financing risks associated with digital assets. It also encourages firms to share information and use emerging technologies.