“Govcoins”, also known as central bank digital currencies, are cryptocurrencies issued by governments and backed by their central banks. These types of cryptocurrencies will operate essentially as fiat currency (explained below) does, albeit in a blockchain form. The South African Reserve Bank (SARB) is currently conducting a feasibility study on the use of a rand Govcoin, the results of which are expected to be delivered in 2022.
Indeed, Govcoins may soon become widespread, however while the advent of these electronic currencies may present a multitude of benefits (cheaper transactions, easier access, better government control over interest rates) they also present difficulties (environmental concerns, privacy issues, excessive state control). Questions arise on how Govcoins will be regulated, the powers they will allow central banks to tap into, and if they mean the end for traditional decentralised cryptocurrencies such as Bitcoin, Ethereum or ZARP – the South African stablecoin cryptocurrency.
Cryptocurrency has taken the world by storm, promising a new era of money and exchange. Many still speculate that the inherent riskiness of cryptocurrency, which is driven largely by market expectations, will lead to an inevitable “burst” of its bubble and that the currency will crash. However, while some cryptocurrencies are riskier than others, they symbolise a new method of payment – digital currency – yet to be explored. There are three types of cryptocurrency: Govcoin, stablecoin, and unstable coins (e.g. Bitcoin). Stablecoins are pegged to a currency but, unlike Govcoins, are not backed by a central bank. Unstable coins are not pegged to any currency and are more volatile than their counterparts.
What is traditional fiat currency?
Any discussion of Govcoins would be remiss without a brief revision of what fiat currency is. Fiat currency is the government issued and backed currency used on a day-to-day basis – your dollars and rands. Fiat currency is valued relative to other fiat currencies and, broadly, represents the demand for your currency relative to another country’s currency. Simply put, where one country’s currency is in high demand, its price will increase. This may happen when it has a high investment rate and external investors buy into that economy, increasing demand for that currency. Of course, many other factors contribute to the supply and demand of any fiat currency – including interest rates and political/economic stability – but for our purposes, a simplified understanding will serve. Govcoins will gain and lose value as the fiat currency it is pegged to does.
What are Govcoins?
Govcoins would represent a similar method of exchange to fiat currency, albeit in a blockchain-mined form. They would still be backed by a government as legal tender, but they would not necessarily be held with commercial banks and they would be produced differently to the electronic representation of money we already have – e.g. the electronic representation of your bank account. Only one large economy, China, has conducted live trials of its Govcoin, the e-yuan. Several other nations are developing their own Govcoins – including Sweden, the Bahamas, Great Britain and Cambodia. Transacting in Govcoin would mean that consumers would directly hold their Govcoins through a central bank, e.g. with a digital wallet, instead of using a traditional account with a commercial bank.
Other cryptocurrencies are a form of decentralised finance (DeFi). ‘Decentralised’ because these blockchain-based forms of finance do not rely on any central bank or commercial banks. Stablecoins, while also pegged to a fiat currency like Govcoins, are not backed by a central bank. A blockchain is essentially an open-source digital ledger of transactions that is duplicated and distributed across an entire network of computer systems on the blockchain. Each ‘block’ in the chain contains a number of transactions and each new transaction is logged in each participant’s ledger.
Blockchain technology is complex, without going into too much detail, I will borrow the elevator pitch of the concept:
You (a “node“) have a file of transactions on your computer (a “ledger”). Two government accountants (let’s call them “miners”) have the same file on theirs (so it’s “distributed”). As you make a transaction, your computer sends an e-mail to each accountant to inform them.
Each accountant rushes to be the first to check whether you can afford it (and be paid their salary “Bitcoins”). The first to check and validate hits “REPLY ALL”, attaching their logic for verifying the transaction (“proof of work”). If the other accountant agrees, everyone updates their file…
This concept is enabled by “Blockchain” technology.
Original article is found here.
A large amount of processing power is needed to produce and manage blockchain based currencies, leading to concerns regarding the cost to the environment should the use of cryptocurrency become widespread.
Like other cryptocurrencies, Govcoins would use blockchain technology for production and transactions. However, because they would be held with a government central bank, Govcoin transactions will be visible to that controlling central bank – who could access the ledger of transactions. This leads to concerns for consumers about their privacy and about excessive state power over consumer spending. Currently, most consumers spend through private banks and their transactions are private, not accessible by the general public. Blockchain technology, without appropriate safeguards and technological development, could allow central banks to view every purchase by consumers using Govcoins. Understandably, consumers would be reticent to use Govcoins without proper infrastructure and regulation to assure them of the privacy of their transactions.
How could Govcoins be used in relation to other currencies and cryptocurrencies?
How the world responds to Govcoins will depend on how they are regulated and if competing, truly decentralised, cryptocurrencies are banned in those countries. China, for example, trialled the e-yuan with an expiry date, incentivising consumer spending of those coins and stimulating their economy that way. This, again, lends to concerns that Govcoins could be another method of state control over its citizens. China has also banned the use of other cryptocurrencies within its borders. In South Africa, the Financial Sector Conduct Authority (FSCA) has indicated its intention to regulate cryptocurrency in the coming years, although it will not be recognised as legal tender or electronic money. Indeed, the South African Revenue Service regards cryptocurrency as taxable, in theory if not yet in practice. This indicates that the South African government envisions embracing decentralised cryptocurrency use, and possibly that any future e-rand (Govcoin) will coexist with decentralised cryptocurrency. In other words, consumers could choose to use their traditional rands (physical or electronic), e-rands, or even (where possible) Bitcoin, Litecoin, Ethereum, etc. E-rands would likely exist complementary to traditional rands. The SARB expects to have concluded its feasibility study on e-rands by 2022, and should proceed with a plan if the study is favourable.
While Govcoins may succeed in cutting out the middleman (commercial banks) and rendering transactions more affordable, they could, if not regulated properly, lead to overexertion of state power, at the expense of the currently blossoming worldwide cryptocurrency industry. Current and truly decentralised cryptocurrencies carry their own risks but also their own benefits, the interplay between the two technologies will shape the future of money and monetary policy across the globe in years to come.
About the author
Megan started her articles with Dunsters in 2020 and is a graduate of the University of Cape Town (B.COM PPE, LLB). Megan is in the commercial team at Dunsters and enjoys working on drafting all kinds of contracts as may suit our clients’ needs. Her areas of interest lie broadly in the commercial sphere, with a more specialised focus on technology and the law. Megan also writes and oversees the editing of our insights and articles.
In her spare time Megan is Chairperson of the Cape Town Candidate Attorneys’ Association, loves to paint and prefers to spend her weekends outdoors. Cold-water swimming, running and hiking, she is keen on all the outdoor activities Cape Town has to offer.