The future of Canada’s financial technology is getting less foggy as COVID-19 pushes the Bank of Canada to dip their toes in trading in digital currency, and it’s just a matter of time until they are implemented.
In February, the Bank’s Governor Timothy Lane said that the pandemic might lead them into accelerating the process of developing a digital currency.
“For several years, the Bank of Canada has been analyzing which circumstances might lead Canada to decide to issue a digital currency. The pandemic may bring us to a decision point sooner than we had anticipated,” he said during a speech about the digital economy and payments innovation.
Lane also noted that the pandemic has caused a spike in growth for cryptocurrencies like bitcoin, but that it is only “speculative mania,” saying they are not “plausible as the currency of the future.”
Cryptocurrencies are a form of digital or virtual currencies, which have been gaining popularity as businesses and the economy have transitioned to working online over the past decade.
“The original aspect of cryptocurrencies was to substitute money, and money is not an investment, right? If you take money, you buy stock, or if you take money, you buy gold, buy a house, that’s an investment,” says Andreas Veneris, a professor of Computer Engineering and Electronics at the University of Toronto.
Unlike fiat money, such as government-issued currencies like the Canadian dollar or the American dollar, cryptocurrency doesn’t have to go through a financial institution in order to be transferred, utilized, and stored. It also isn’t monitored in the same way by the government.
Instead of going through banks or other financial institutions, cryptocurrencies run on blockchain technology, which is sometimes referred to as a digital ledger. A blockchain is decentralized, and consists of a series of “blocks” that store data recording online transactions. Each block has the transaction details as well as how many coins or digital currency a person has.
The more transactions individuals make, the larger their blockchain gets as new transactions create more blocks.
With fiat money, the transactions are approved by a financial institution. However, when it comes to bitcoin, these “transactions are validated by a network of users called ‘miners,’ who donate their computer power in exchange for the chance to gain additional bitcoins…” reads a report by Deloitte.
The benefits of decentralization mean that there is no one location where the blockchain can be stored, which makes it almost impossible to hack.
Asides from being decentralized, the blockchain is also protected by an encrypted code that prevents hackers from stealing digital assets. In order to get a hold of the digital asset, an individual must have their own private key, which can unlock the encrypted code. Miners also try to help keep the blockchain from being hacked by solving complex mathematical problems in order to validate each transaction. Once they solve the problem, they are able to add a block into the chain.
Completing the mathematical problem is called “proof of work,” and the process of adding a block into the blockchain is called “mining.”
“The essence of blockchain is that the things that today happen with a trusted middle authority, they can happen in a decentralized way. And that’s the pure revolution of blockchain.” says Veneris.
“It’s now 10 years in the making. Nobody has attacked Bitcoin or Ethereum, or other blockchains. But it is this concept of decentralization, one that, especially as we move into the decade of artificial intelligence, Internet of things, data harvesting, data protection, I think it will be of paramount importance for us — the people — to maintain our rights and secure our rights against the big interest in the big capital,” he says.
In terms of Canada adopting digital currencies in the future, Veneris suggests that it isn’t a matter of “if, but it’s a matter of when, and the sooner the better.”
China has already launched their pilot of e-currency as they strive to become a cashless society. Unlike bitcoin, which is decentralized and uses blockchain technology, China’s digital yuan is controlled by the country’s central bank, the People’s Bank of China.
In 2018, the Bank of Canada released a report titled, “Should the Central Bank Issue
E-money?” The document analyses and questions the usage of digital currencies.
“Would a central bank e-money system enhance or hinder financial stability, increase or reduce bank deposits and bank lending? Some central banks might be motivated to issue e-money as a reaction to the reduction in seigniorage that comes with the fall in the usage of cash.”
Seigniorage refers to the difference between the value of money and how much it cost to produce it. For example, the difference between $20 and how much it costs to produce a physical $20 bill.
Cash and digital currencies “cannot be equivalent because cash and digital
tokens have different tradeoffs of security and privacy,” the report suggests. This is because cash doesn’t use blockchain technology as some digital currencies do.
Some benefits of adopting digital currencies are “the possibility of reducing criminal and underground activities [that have] been advocated as a worthwhile reason to eliminate cash…. Since the elimination of cash would likely require alternatives, a central bank e-money system would be a clear candidate,” reads the report.
However, the Bank of Canada questions if the anonymity of digital currency is something that Central Banks can work with. A cryptocurrency address is entirely anonymous but is also transparent and trackable.
A crypto address is created each time someone creates an invoice or receives a payment request. These addresses are made up of random letters and numbers that are anonymous and don’t reveal anything about an individual’s identity.
“If we tried to send a million dollars from Canada to Hong Kong, for example, the government would know about it. We have to file papers about the numbers that we’re exploiting. But if it’s bitcoin, the ledger is not stored in one specific country. It’s stored on thousands of computers worldwide,” says Kwantlen Polytechnic University economics instructor Michael Leonard.
“So money can move, bitcoin can move from one person to another, secret to the government. And that’s the best use for money laundering,”
In the report, the Bank of Canada discusses whether anonymity and privacy should be part of public policy considerations if adopting digital currencies.
“This comes, of course, with drawbacks because anonymity might facilitate nefarious activities,” the report reads. “Still, a central bank e-money system could be designed to balance the legal demand for anonymity and privacy with its risks, possibly offering more or less anonymity than cash.”
However, Leonard says he doesn’t think Canada will adopt these digital currencies as quickly as some expect.
“The government makes money by issuing currency. So, for example, when a bank gets a new $10 bill from the government, the government gets $10. But it only costs about 25 cents to issue that. So they can produce a $20 bill for 25 cents, and then they sell it to a retailer for $20. Why would they give that up?” he says.
“As the economy grows, the government has to give us more money to play with, otherwise, you don’t have enough money in your pocket to buy the things that you want to buy, not because your income is too low, but because they don’t have money,” says Leonard.
Since 2020 however, Canada, along with other countries, has been taking a closer look at digital currencies.
“The Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Sveriges Riksbank and the Swiss National Bank, together with the Bank for International Settlements (BIS), have created a group to share experiences as they assess the potential cases for central bank digital currency (CBDC) in their home jurisdictions,” reads a press release by the Bank for International Settlements.
The Bank of Canada also posted an article that looks into how the Canadian digital currency could play out in the future, which indicated that there could be two broad approaches, a value and an account-based approach.
The value-based approach would be when “people transfer money from their bank account to a card or a phone app.” The account approach would be when “people and businesses can open an account at the central bank.”
The article states that “payments made using a central bank digital currency could allow payments to remain private to the parties involved, just like cash; but traceable to law enforcement, just like bank accounts.”
The Bank of Canada has not confirmed any other details that would suggest how the digital currency will be created, but some are raising concerns about the sustainability of using energy to create and sustain cryptocurrencies at the same scale as fiat money.
On average, one bitcoin is mined and verified within 10-minutes. However, the process of mining these coins is beginning to require more energy, which will continue if the world starts to adopt cryptocurrencies more widely.
“Undoubtedly bitcoin mining consumes less energy than the other systems like gold mining, banknotes, coins, and the banking system, but considering the transition of all monetary systems into the new cryptocurrency, this will result in a huge amount of energy consumed to mine new bitcoins and to maintain the entire virtual monetary system at the actual bitcoin mining rate,” reads a 2017 report from Italian researchers titled “Current Trends in Sustainability of Bitcoins and Related Blockchain Technology.”
Most of the bitcoins mined are not all running on green energy. The University of Cambridge estimates that bitcoin mining consumes 128.00 terawatt-hours a year, which is more electricity than the entire country of Argentina.
Computers not only need the energy to solve complicated equations, but they also need cooling to prevent them from overheating. This means that mining farms will need even more energy for ventilators or air conditioners. In addition, once these computers stop functioning, they will be thrown away creating the disposal of electronic waste.
“As a result, depending on where these computations occur, electricity can be quite dirty in some locations because it uses coal in generating electricity,” says Werner Antweiler, a professor at UBC Sauder School of Business.
“The use of coal in electricity production is the greatest contributor to these emissions, and it is also noted that it is burning coal which accounts for 60% of sulphur dioxide emissions in the atmosphere,” reads a report titled “Bitcoin Mining and Its Environmental Effects.”
According to the report, two of the countries that are leaders in coal energy production are China and India.
“Let’s take the United States, where in the eastern part of the country’s interconnection, there is a very significant amount of coal in every kilowatt-hour that’s being produced. So using electricity anywhere from New York, to Georgia it’s…a very significant environmental impact. In the rest of the country, electricity is much cleaner. We have hydro in the mix and even renewables like solar and wind,” says Antweiler.
However, it isn’t all bad news. A report from the Cambridge Centre for Alternative Finance found that in 2018, 76 per cent of crypto miners used renewable energy in some parts of their work. But “the share of renewables in hashers’ total energy consumption remains at 39%.”
In the report, 62 per cent of surveyed crypto miners use hydropower, 38 per cent use coal, 36 per cent use natural gas, 17 per cent use wind, 15 per cent use oil and solar energy, 12 per cent use nuclear, eight per cent use geothermal energy, and two per cent use other types of energy.
As the Bank of Canada ponders on their next steps of financial technology, there is only hope that the sector can find ways to create a sustainable digital currency.