Reem Ebrahim Alhosani*
With the rise of the digital revolution, reliance on digital services, e-commerce and financial technology has grown substantially. Digital or cryptocurrencies have opened new avenues for investment, just as the end of World War II marked the beginning of a global financial system centered around the US dollar, which was initially tied to gold prices before that link was severed.
Trust in virtual currencies has increased in recent years, driven by global developments, particularly the COVID-19 pandemic, which significantly contributed to a surge in online shopping and reduced reliance on cash, boosting interest in digital currencies due to their low transaction costs and ease of use. However, these currencies also come with significant risks, including high price volatility, fraud, hacking, and uncertainty around legal and regulatory frameworks. Moreover, some countries either do not recognise or ban cryptocurrency trading.
On a non-governmental level, cryptocurrencies have been favoured by individuals because they are free from centralised oversight. These currencies are stored in encrypted records on computers, and their value is determined by supply, demand and market dynamics. While their everyday use in transactions remains limited, they are now accepted at some hotels and stores. In the near future, cryptocurrency payment services could become more widespread worldwide.
Government and financial institutions have been slow to respond to cryptocurrencies within the international financial system, largely because these currencies operate outside of traditional financial mechanisms. However, many central banks around the world are now planning to issue their own digital currencies and are developing regulatory frameworks to govern them. The UAE is among the leading countries in this area. According to estimates by the Atlantic Council, 143 countries are working on issuing central bank digital currencies (CBDCs).
CBDCs are digital versions of traditional money designed for electronic transactions. While they cannot be converted into physical cash, they hold the same value. The growing interest in using digital currencies as a payment method aims to preserve the role of major central banks. This shift provides a reliable currency for exchanging value and managing finances, while also offering a means to expand access to financial markets. It also increases financial inclusion by making digital currencies available to individuals without access to traditional banking services. Additionally, digital currencies can reduce the need for currency exchanges between countries, simplifying international trade and lowering its costs. However, they also come with risks, such as facilitating illegal activities like money laundering, terrorism financing, and circumvention of the conventional banking system.
Regulation and legislation remain critical challenges in ensuring consumer protection and preventing illegal activities in the world digital currency. Issuing licenses for digital asset service providers is essential to ensure that storage, transfer, exchange, and settlement services are governed by clear, established rules. Without proper regulation, digital currencies could undermine both monetary and financial stability.
However, regulation alone is not sufficient. Digital currencies also require the development of advanced technological infrastructure, a solid banking system and strong regulatory capabilities to address potential negative impacts. Striking a balance between innovation and regulation is crucial for protecting consumers and maintaining the stability of financial markets. Governments must work on enacting laws and regulations that govern the use of virtual currencies and must also establish mechanisms for international cooperation to coordinate efforts aimed at preventing the illicit use of these currencies.
Digital currencies have become an integral part of the global financial system, particularly in financial services, capital market trading, cross-border settlements and trade finance. Consequently, there is a need for comprehensive mechanisms to regulate and oversee digital currencies globally, as their very nature transcends sectors and borders. Digital currencies promise to simplify transactions, promote financial inclusion, increase transaction speed and efficiency, reduce costs and improve transparency. However, they also pose challenges that require policymakers to exercise caution and adapt to the changing reality. As digital currencies are still in their early stages of development, digital systems remain susceptible to cyberattacks. Furthermore, mechanisms to combat the use of digital currencies in illegal activities are still limited, increasing the risks associated with the transformation of the financial system. Cooperation is vital for regulating digital currency trading between countries and international financial institutions. It is also important to develop financial technologies that create a balance between innovation and consumer protection and contribute to transparency, safety and trust in financial markets.
*The author is an assistant researcher at TRENDS Research & Advisory