VIRTUAL MANAT

We can see a growing interest of central banks in digital currencies. Initially negative, governments around the world are now declaring the benefits of digital currencies and moving from theory to implementation.

This process has been going on in Azerbaijan as well. Thus, CBAR has already started the analysis of introducing digital manat and expects to receive initial results of the study in 2022.

Coronacrisis as an acceleration factor

More than a hundred countries are at some stage of exploring the possibility of introducing CBDCs. This encourages others to explore the adoption of digital currency as well. For example, Japan has accelerated the research amid China's announcement of a pilot digital yuan regarded by Tokyo as a threat to its financial security.

Obviously, China has become a global leader in digital currencies, with more than $5 billion in digital currency transactions in the country in 2020.

However, experts believe that digital currency, even with the most optimistic forecasts, will not replace fiat money until 2030s.

The digital currency is promised to be similar in functionality to non-cash, but will formally become a third form of payment in addition to existing cash and non-cash ones.

Financial authorities of various countries developing their own digital currencies indicate that they will have nothing to do with cryptocurrencies, as they will be issued by a single issuing centre represented by the Central Bank, whereas the main attribute of cryptocurrency is decentralisation.

Meanwhile, the COVID-19 pandemic has greatly increased the popularity of contactless and online payments globally. Firstly, it was due to the lockdowns declared in many countries around the world, as people could not leave their homes and had to shop online. Secondly, the phenomenon is associated with hygiene, as fiat money is often referred to as one of the reasons behind the spread of viruses.

PriceWaterhouseCoopers (PwC) has recently published a forecast predicting global non-cash transactions grow by 80% by 2025—from around 1 trillion transactions in 2020 to almost 1.9 trillion and triple by 2030.

Non-cash transactions are also on the rise in Azerbaijan. According to CBAR, in January-November 2021 the number of online transactions and mobile banking increased by 60.5% and 3.8 times respectively compared to the same period in 2020.

Amid the global lockdown restrictions, e-commerce turnover in Azerbaijan reached ₼6.1 billion in the first eleven months of 2021, having increased 1.8 times over the year.

The infrastructure of cards also expanded: the number of contactless cards in circulation doubled in the first 11 months of 2021, while the number of POS-terminals increased by 29%. The volume of non-cash card transactions increased by 75.4% over the same period.

Benefits and risks

Initially, the risks and benefits of digital currencies go hand in hand. For example, people are reluctant to become completely transparent in terms of trusting the central banks information about their spending. Or the low cost of non-cash transactions, but a relatively expensive switch to digital currency.

The first advantage that is usually mentioned by experts is that all transactions are controlled by the government and there is transparency. However, a lot depends on the model of implementation - whether digital money is based on user accounts or through digital tokens. Either way, there will be no complete anonymity of transactions.

Perhaps that is the most important factor, because it can also scare people away. This has already happened in Ecuador and Venezuela, which were the first to announce the introduction of digital currencies. Yet both projects failed, primarily because people in those countries do not trust central banks.

The second advantage is cheapness. It is not just a matter of reducing costs because you do not have to print money. It can also include the cost of transporting physical money and the associated security costs.

Banknotes themselves also have a life span and can be in circulation from 1 to 15 years (about 30 years for coins), depending on how often they are used. Usually small notes wear out faster. And it costs money not only to issue new banknotes, but also to destroy the old ones.

However, the readiness of the financial infrastructure to handle this volume of transactions has to be taken into account. It will also be necessary to make sure POS terminals are available in every shop across the country.

Banks should play the leading role

According to Emil Mehdiyev, IT director of a local bank, the introduction of digital currency will give a big boost to the digital economy. After all, digital currency not only combines the advantages of cash and non-cash, but also has a number of other features. As each unit of digital currency has a unique identifier, it is possible to track the movement of specific funds. This feature will make it much easier, for example, to monitor the spending of public funds. Another advantage of digital currency is the possibility of implementing smart contracts. This will not only reduce the number of payment intermediaries, but will also significantly speed up the signing of contracts between merchants. Time to conclude a transaction with the corresponding payment will be reduced from a few days to a few minutes, according to Mehdiyev.

As to cyber security, the expert said that it would definitely increase with the digitalisation of the economy. The cost for banks to maintain digital security is increasing every year. Cybersecurity will be a major focus in the implementation of digital currencies. Since digital currencies are introduced by central banks, they will already be secured. Other banks, on the other hand, will have to secure customer access to digital currency wallets.

Mr. Mehdiyev believes that banks should definitely play an active role in the process of creating the digital manat: "And not only banks. As the digital currency needs appropriate infrastructure to function fully, it would be useful to consult, for example, with telecom operators, with businesses, with a dedicated group of users before introducing it.”

Experts believe that there should be no fees for remittance services between the seller and the buyer. With all of these points in mind, the whole concept of global banking could change fundamentally with the introduction of digital currencies.

It should be noted that the transition to digital currency does not free the national economy from the risks associated with the cash currency: inflation, exchange rate movements, etc. For example, emission of one cybermanat will result in one cash manat being withdrawn from the circulation. But there will be no need for financial intermediaries between the seller of goods or services and consumers. Digital money will go directly from one electronic wallet to another, bypassing transit routes through commercial bank accounts. And the money will even be transferred offline, without access to the internet. It will also not require a bank account.

Experience in neighbouring countries

Introduction of digital currencies is also an issue for Azerbaijan's neighbouring economies. In Turkey, digital lira is of particular importance. An associated pilot programme for its development was launched in 2018. In September 2021, the Turkish Central Bank announced that it had signed agreements with defence and technology firms Aselsan, Havelsan, and the Scientific and Technical Research Council of Turkey to collaborate on research into the development of the digital currency.

The country's population is open to such technology, as about 16% of Turkish citizens have owned a cryptocurrency at least once in their lives (Statista Survey). Today, approximately 1 million Turkish citizens use various forms of cryptocurrency. Therefore, the government needs to move these citizens into a controlled space. A digital currency with a citizen identification system issued by the Central Bank is better than decentralised cryptocurrencies.

But almost half of the country's citizens, according to ING Bank, are willing to keep money in cryptocurrency if the lira continues to fall in value.

The Bank of Russia is also working on the digital rouble. The regulator plans to create a prototype of the digital rouble platform. Last June, a pool of 12 banks willing to participate in testing the digital rouble was created. Test platform is scheduled to be launched in the first quarter of 2022 and will last until the end of the year. A roadmap for the public introduction of the digital rouble will be developed based on the results of the test.

2022 is a decisive year

Meanwhile, the Central Bank of Azerbaijan expects to receive the initial results of analysis on the introduction of digital currency in 2022. CBAR General Director, Farid Osmanov, says that his organisation is closely monitoring the digital transformation, analyses the opportunities of digital currency, as well as the associated threats and risks. CBAR is currently preparing a document on the conceptual approach to digital currency.

In short, we can say that Azerbaijan is already working to create a digital manat using the experience of neighbouring countries.

Thus, CBAR intends to continue the assessment of the introduction of digital currency in the medium term in the following areas: policy definition, purpose of digital currency application; involvement of stakeholders in the process; development of the legislative framework; potential use of new generation technologies; the level of market readiness.

In addition, CBAR will also work on several projects to develop the digital ecosystem in 2022. These include a project on digital payments in public transport through bank cards and mobile banking, expanding the reach of POS terminals in business entities, as well as creating opportunities to accept QR code payments in cases where there is no payment option through POS terminals.

As to the creation of a digital currency, CBAR First Deputy Alim Guliyev said that CBAR was working closely with international think tanks, in particular with the Turkish Central Bank to study the experience of Russia and Kazakhstan in this matter.

The regulator said that the results of the first phase will be announced in 2022 after the tests are completed.

Presently, it is difficult to say what the digital manat will look like. There are many configurations and possibilities: CBAR can control the whole process alone, or it can involve intermediaries such as commercial banks or outsource the whole business to them. The infrastructure that will hold everything together can work either through a conventional centralised database or distributed registry technology with restricted access. Moreover, the digital manat can only be used domestically or become a cross-border currency. However, it is unequivocally accepted that the digital manat should emerge sooner or later, given the global trend in this direction.