What CBK should consider before rolling out a local digital currency

Digital currency is any currency, money or money-like asset that is exclusively available in electronic format. Examples include cryptocurrency, virtual currency and central bank digital currency. They are traced to when American computer scientist and world-renowned cryptographer David Lee Chaum invented digital cash, which relied on cryptography to secure and verify online transactions.

Chaum’s 1982 dissertation, “Computer Systems Established, Maintained and Trusted by Mutually Suspicious Groups”, is the first known proposal for the establishment of a blockchain protocol. Data is broken up into shared blocks that are chained together with unique identifiers in the form of cryptographic hashes, enhancing data security. 

The groundbreaking research allowed users to obtain digital currency from a financial institution and spend it in a manner that cannot be traced by the bank or any other party.

In October 2008, a paper by Satoshi Nakamoto (a pseudonym), “Bitcoin: A peer-to-peer Electronic Cash System”, outlined a system for creating a digital currency that didn’t require trust in a third party and the use of peer-to-peer network to eliminate the double spending associated with digital currency. His proposal culminated in blockchains, effectively setting in motion the inexorable march of cryptocurrency technology.

With decentralised cryptocurrencies that store value but aren’t overseen by any authority, central banks are mulling over creating their own digital currencies to modernise their financial systems, ward off competition from cryptocurrencies like bitcoin and hasten domestic and international payments.

Increasing financial inclusion

A central bank digital currency (CBDC) is issued and managed by a country’s central bank with government backing. China’s CBDC programme is one of the largest and most advanced with various trials and pilot schemes carried out since 2020. More than 260 million people had opened e-CNY digital yuan wallets by the end of last year and used it to transact $4 billion (Sh1.6 trillion).

A Working Group on e-CNY Research and Development research paper last year says the e-CNY has three key objectives. One is to diversify the forms of cash provided to the public, satiate the demand for digital cash and bolster financial inclusion. Two, enhance fair competition, efficiency and safety of retail payments services. Three, echo the international initiative, easing cross-border payment. Despite its great strides, China trails global leaders like the Bahamas and Nigeria.

In October 2020, the Bahamas introduced the sand dollar, a digital version of the Bahamian dollar, which can be accessed via a mobile app or physical payment card. It’s expected to inject efficiency in the payments systems, foster greater financial inclusion and check money laundering and counterfeiting.

Last October, Nigeria became the first African country to launch a digital currency. The eNaira employs the same blockchain technology as bitcoin and is aimed at increasing financial inclusion and facilitating remittance inflows into the populous country.

With digital money now an established part of the global financial ecology, the Central Bank of Kenya (CBK) recently announced the issuance of a “Discussion Paper on Central Bank Digital Currency” to determine the applicability of a digital shilling in the financial ecosystem.

Erosion of citizens’ privacy

Likely benefits include elimination of currency counterfeiting and money laundering, dramatic reduction in production and administration of physical currency, increased financial inclusion for the unbanked, improved tax collection as majority of financial transactions pass through the formal systems and faster cross-border payments.

But in spite of the stated benefits, there are concerns that ought to be addressed before a digital currency is rolled out. First, it might lead to erosion of citizens’ privacy as authorities have the ability to track the digital currency’s creation, issuance and transactions.

Secondly, opening digital wallets directly at CBK could deprive commercial banks of deposits. The deposit flight would impair lending, disincentivise investment, slow down economic activity and, ultimately, lead to unemployment. It could also negatively affect valuation at the Nairobi Securities Exchange (NSE) as bank stocks could drop in value.

Thirdly, as central banks exercise absolute control over their CBDCs, they could put restrictions on the types of transaction they permit, curtailing freedom of expenditure. 

Finally, it might take time for CBDCs to gain traction since not all Kenyans have the means to access digital currencies.

Mr Maosa is a banking and finance expert. [email protected] @ndegemaosa