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Next stop in the cryptocurrency craze: A government-backed coin

  • Central banks around the world, including China, Japan and Sweden, are developing their own cryptocurrencies.
  • Peter Smith of Blockchain says we are 24 months away from a major government issuing a sovereign digital currency.
  • A Federal Reserve official said this week that the U.S. central bank is thinking about its own digital currency, but it is years away.

In the light of the rising popularity of cryptocurrencies, like bitcoin and ethereum, central banks around the world are busy experimenting with their own versions of cryptocurrency, or digital currency.

China's central bank announced in January that it has completed a successful trial run of transacting digital currencies among banks. Then in September, Japan, Sweden and Estonia all announced similar digital currency projects: J-coin for Japan, E-krona for Sweden and Estcoin for Estonia. The roster doesn't stop there — the UK, Uruguay and Kazakhstan have all expressed similar ambitions.

On Wednesday, William Dudley, president and CEO of the Federal Reserve Bank of New York, said the Fed is exploring the idea of offering its own digital currency, according to published reports on comments the Fed president made at a conference. However, Dudley said it would be "very premature" to estimate when the Fed would come up with its own version of bitcoin.

How soon will we see a government-backed digital currency up and running? This past summer Peter Smith, CEO of Blockchain (the leading digital wallet), predicted that "we are 24 months from a major government issuing a sovereign digital currency."

This global phenomenon is so new that no one has yet to solidify a term to address it. Some call it central bank–issued cryptocurrency or government-backed cryptocurrency. Some refuse to call it cryptocurrency, naming it digital fiat or sovereign digital currency.

"To me the idea of cryptocurrency is free of control from any person and institution. There's nothing cryptocurrency about these [government-backed projects]," said Jacob Eliosoff, investment manager of Trevi Digital Assets Fund.

He added: "You have one institution that controls it, and they can change the rules when they want; they can prevent certain transactions from happening if they don't trust the party involved. It's not that that's bad, but that's not a cryptocurrency. That's just a currency that happens to run on a computer. "

Bitcoins
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Driving this global trend is a confluence of factors.

Governments are now responding to the rise of cryptocurrencies. It is a global market composed of a number of virtual currencies — i.e. bitcoin, ethereum, Zcash, dash T— that has reached $335 billion in size, according to CoinMarketCap. And it is expected to reach $2 trillion in 2018, predicts Mike Novogratz, a billionaire trader and long-time cryptocurrency bull who forecast a bitcoin price increase by the end of next year to as high as $40,000.

This year alone, Bitcoin's value has soared about 900 percent hitting more than $11,0O0 Wednesday. At the same time, ethereum's value rose a whopping 5,900 percent to $519.85 on Wednesday.

Investors in cryptocurrencies have been riding a tremendous bull run, outpacing stock market returns by a huge margin so far this year. The S&P 500 is on track for a 20 percent annual return, but meager when compared to such cryptocurrencies as bitcoin.

Many countries concerned about the future of finance are tracking the digital currency movement, and they are developing strategic plans for adoption. "I think China, in particular, as opposed to some other countries over the last four years, felt the threat of the rise of bitcoin and other cryptocurrency," said Paul Triolo, practice head of geotechnology at Eurasia Group. "The [Chinese government thinks] that [cryptocurrencies] could potentially threaten the central government control over the financial system."

"We are 24 months from a major government issuing a sovereign digital currency." -Peter Smith, CEO of Blockchain

Governments also see blockchain — the underlying technology of cryptocurrencies — as a way to move forward or perhaps even to get ahead of the trend. In countries like Sweden and China, cash is giving away to more convenient mobile payment systems. Last year only 15 percent of retail payments in Sweden were made in cash, a steep drop from 2010, when cash payments accounted for 40 percent.

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"There's this really interesting prospect of creating a platform for innovation," said Xen Baynham-Herd, head of strategy and lead economist at Blockchain. "If a government was able to issue a second currency in digital form, it would be a building block of the money for the internet. You can imagine micro transactions and cross-border payments happening as easy as sending an email to someone."

The value proposition

How would these government-backed digital currencies affect the value of cryptocurrencies? This is an open question, as there are no existing government-backed digital currencies implemented at scale.

Triolo thinks "bitcoin would probably be the one that's mostly affected, because it was originally intended to be used as a digital currency." But he's bullish on ethereum and others that are more tied to broader application platforms than just currencies.

Baynham-Herd disagrees and thinks bitcoin could become digital gold. "I think bitcoin and other crypto will coexist with government-issued cryptocurrencies, because they offer different things. Bitcoin, from the very beginning, was all about decentralized, peer-to-peer digital cash, without the need for central intermediary, without the control of a government, and these features remain whether or not a government issues its own digital currency."

While Trevi's Eliosoff sees real opportunities for cryptocurrency in cross-border transactions. Baynham-Herd sees the opportunities in "combining the innovative features of bitcoin and other cryptocurrencies with the established trust and security of a currency issued and regulated under a central bank and a government."

Meanwhile, Rod Garratt, an economic professor at UCSB (University of California, Santa Barbara), thinks "if there was a central bank cryptocurrency that provide some anonymity, then it would be a very close substitute for bitcoin, except it would not provide autonomy. So it really comes down to what feature people desire."

"Central banks don't get to decide whether or not bitcoin is there or not; bitcoin is there," said Garratt.

To be sure, cryptocurrencies are global technologies, proved to be resilient to government regulation (the bitcoin price rally was undeterred in the last few months after China shut down cryptocurrency exchanges and ICOs in September). So it remains to be seen if governments are able to develop digital currencies that can rival with bitcoin and others.

— CNBC's Evelyn Cheng contributed to this report.

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