Digital currency eNAIRA

What is a digital currency and how does it work?

 Central bank digital currencies are issued and regulated by a country's monetary authority or central bank and are backed by the government. 

They differ from existing central bank electronic money, which is provided by central banks but can only be used by banks and certain financial institutions. 

When financial institutions make payments to each other, they deposit with reserves in accounts they maintain with a central bank.

Prior to the introduction of central bank digital currencies, consumers could only use money that was a direct responsibility of a central bank in the form of cash. 

Existing retail digital payments, which are customer deposits to bank accounts, are based on money that is the responsibility of the institution holding the account, not a central bank. 

A central bank's digital currency is a direct responsibility of the central bank and is available to all households and businesses, giving them access to central bank electronic money.

Nigerian digital currency will be the digital form of the naira and will be used as cash.

A central bank's digital currency is not a crypto-currency. Crypto-currencies, such as bitcoin, are not currencies in most countries because they are not a widely accepted form of payment.

 Although they are still often referred to as crypto-currencies, they are better described as digital assets or crypto-assets.

The Bahamas, St. Lucia, Grenada, Antigua, and Barbuda are among seven countries that have adopted central bank digital currencies.

Why did Nigeria adopt a digital currency?

The central bank gave several reasons for the introduction of the eNaira. It aims to:

• promote and facilitate financial inclusion
• enable direct payment of social benefits to citizens
• facilitate remittances from the diaspora
• reduce the cost of handling cash
• improve the availability and use of central bank money
• increase revenue and tax collection
• support a stable payments system
• Improve the efficiency of cross-border payments.

The introduction of the eNaira will allow peer-to-peer payments, eliminating the need for intermediaries and financial institutions.

What are the risks?

One is the risk of disrupting existing banking systems. This could be the case if citizens decide to hold digital currencies instead of keeping their physical naira in a bank account. 

This would mean that banks would run out of money to issue loans and other financial products. This could lead banks to raise their interest rates to encourage customers to keep their deposits with them. But then lending rates would also rise to cover the interest on savings.

However, since all money is non-interest bearing and the central bank can set transaction and balance limits for certain eNaira portfolios, this risk is minimized.

The second risk is operational. For example, if computer systems fail or if there are technical malfunctions or cyber-attacks. 

These can compromise the privacy of users. The central bank will need robust technology and IT security systems.

Reputational risk is closely related to the materialization of operational risks. They are likely to have a huge impact on the central bank's credibility and reputation, both nationally and internationally.

If the central bank assumes this new role - issuing the eNaira and maintaining a central registry for all transactions - it may find it more difficult to fulfill its primary mission of ensuring a safe and sound financial system, as it would have to focus on managing the eNaira system in addition to its other responsibilities in the national economy.

One possible way to alleviate this burden is to create synthetic digital central bank currencies. This idea was presented in an International Monetary Fund paper in 2019.  

The financial institutions issue a digital currency, which is fully backed by the central bank's currency.

Closely related to this is the risk that the system will be used for money laundering and terrorist financing.