At the end of 2022, the National Bank of Ukraine ("NBU") released the draft concept of its digital currency, or E-hryvnia, to the payment market and virtual assets market participants. This news has intensified discussions within the professional community about the prospects of E-hryvnia and the best model for introducing it. Let us figure out in more details what central bank digital currency is and how it can work in Ukraine.
What is digital currency?
The central bank digital currency ("CBDC") is a digital analogue of the national fiat currency, i.e. currency backed by the government. It should be distinguished from private currencies and cryptocurrencies that are not backed by state sovereignty. CBDC does not fully replace cashless payments, but supplements them. Digital currency transactions are made via a separate digital system rather than conventional banking system that ensures faster processing of payments and uses cryptography to secure transactions.
The emergence of CBDC was driven by central banks' response to the rapid growth of private currencies and cryptocurrencies. This, in turn, was instigated by the consequences of the 2008 economic crisis and the lack of trust in traditional banking systems. Thus, the primary reason for introducing CBDC is the attempts of central banks to regain full control over their state's monetary policy. However, there are other reasons why central banks are introducing CBDC. For instance, CBDC may be a universal payment instrument in a decentralised financial infrastructure and serve as a useful tool to keep state's financial system in order.
One of the main advantages of CBDC is its reliability, since CBDC is issued by central banks. CBDC transactions require fewer intermediate steps or even eliminate the interbank layer completely when transferring funds through a digital system, resulting in lower costs and faster transaction processing. CBDC payments could compete with traditional payment systems such as Visa and MasterCard. Although CBDC transactions may be easier to trace helping to prevent money laundering, privacy and anonymity remain one of the key factors for clients.
How does CBDC work globally?
According to the Bank for International Settlements, as of 2021, over 86% of central banks were looking into CBDC, approximately 60% were making experiments with CBDC, and almost 14% were launching pilot projects intended to implement CBDC.
There are different types of CBDC, most notably retail CBDC and wholesale CBDC. Under the retail model, CBDC becomes available to individuals and legal entities. In the wholesale model, only professional participants of financial market may access CBDC. In addition, a CBDC system can be centralised or decentralised. In a centralised model, a central bank is the sole issuer of CBDC, while commercial market participants have only service functions. In contrast, in a decentralised model, banks and non-bank financial institutions may be authorised to issue CBDC under central bank's control.
Different countries have different approaches to CBDC, and the race for leadership has already started. China's ambition is to be the first one to fully adopt digital yuan. Chinese system was tested in several cities and provinces in 2021-2022. India hopes to start issuing its digital currency in the 2022-2023 fiscal year. The European Central Bank plans to create a prototype of electronic euro by the end of 2023, and expects it to be fully operational by 2025. Some researchers note that the Chinese model places focus on control of CBDC transactions, while Swedish and Norwegian models permit anonymity of payments.
The success of each product depends on client's interest to use it. That is why the ability of central banks to address key contentious issues, such as anonymity, transaction speed and costs, and security, will allow their product to stand out. As a consequence, CBDC payments may gain a significant niche from cash and non-cash payment.
NBU's draft concept of E-hryvnia
The Law of Ukraine "On Payment Services", adopted in 2021 and effective from 1 August 2022, introduced the concept of "digital money of the National Bank of Ukraine" into Ukrainian legislation. The NBU digital currency is considered as a legally permitted means of making certain kinds of payments in Ukraine for individuals and businesses.
The NBU started developing its own digital currency back in 2016. In 2019, the NBU prepared an analytical note on the results of its pilot project named "E-hryvnia", which had anticipated issuing a limited amount of E-hryvnias and making payments using E-hryvnia. Based on the results, the NBU concluded that E-hryvnia could be an alternative to existing instruments for retail payments. However, the NBU also acknowledged that E-hryvnia could be a so-called "disruptive technology" for the Ukrainian payment market ecosystem, and significantly affect the existing roles of the participants. The full implementation of E-hryvnia is possible only after significant modernisation of Ukraine's payment infrastructure.
The NBU's recently proposed concept envisages that E-hryvnia will be used for retail cashless payments, virtual assets transactions and cross-border payments. The declared goal is to promote digitalisation of Ukraine's economy, expand the share of cashless payments, reduce transaction costs, and increase confidence in Ukraine's national currency. The concept and models for introducing the E-hryvnia are still being discussed. The NBU promised to take into account the needs of market participants and clients.
E-hryvnia is a logical next step in Ukraine's strategy to digitise its economy. This will further reinforce Ukraine's progress with the digitalisation of public services and the Diia City special regime for tech companies. Importantly, for E-hryvnia to be fully functional several fundamental issues must be solved, including finding the right balance between freedoms for users and security. It remains to be seen what Ukrainian lawmakers will decide, especially in light of their attempts to simultaneously develop a regulatory framework for cryptocurrencies and virtual assets.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
