To try and forestall such developments, central banks in all the world’s major economies and most of its lesser ones are exploring the creation of digital currencies, and a handful of emerging economies have already launched their own.

The widespread introduction of central bank digital currencies (CBDCs), especially in the world’s major economies, is not imminent.

But the groundwork being conducted in this area is detailed and in-depth, such that many central banks will be ready to launch when their governments deem the circumstances to be right.

Before that time comes, central banks have choices to make about the design of their CBDC systems, particularly those earmarked for retail use.

We spoke with two experts to understand what some of those options are and how the choices made may have an impact on financial inclusion and the role of private sector banks in this new payments landscape.

The state of play

As of June 2023, 11 countries or their currency unions had fully launched digital currencies, 21 had embarked on pilots, 32 had them under development and another 46 were at earlier stages of researching them.

Some initiatives are exclusively for retail CBDCs (including the 11 already launched), some for exclusively wholesale ones, and several large economies (such as China, the US, and the Eurozone) are exploring the launch of both.

With the exception of Nigeria, all of the 11 that have launched CBDCs thus far are small economies in the Caribbean region.

Why their speed to launch?

According to Marion Laboure, Senior Strategist at Deutsche Bank Research and co-author of a recent white paper on digital currencies, a major motivation for them is to expand financial inclusion, as most have large numbers of un- and underbanked citizens.

For Nigeria, says Ashlin Perumall, a partner in Baker McKenzie’s Johannesburg office, an additional impetus is to shore up the use of its own currency in domestic payments, thereby reducing use of the dollar, as well as to increase the visibility and traceability of money flows.

“There and in other African countries, CBDCs could solve problems that aren’t currently being solved,” Perumall  says.

There is currently less urgency in larger, wealthier economies to move toward CBDC launch. Singapore is a case in point.

After completing a pilot in late 2022, its central bank, the Monetary Authority of Singapore (MAS), stated that: “The use cases for a retail CBDC are unclear, given that electronic payments … are pervasive, and households and firms … are already able to transact digitally in a fast, secure and seamless manner today.”

Speaking of wealthy economies more broadly, Perumall also cites the travails of cryptocurrency markets as a reason for central banks to hold off. “Crypto threats to sovereign liquidity have receded somewhat in the past year,” he says.

The experts we interviewed nonetheless expect several major economies to launch CBDCs this decade. “It’s a question not of if but of when,” says Laboure.

A boon to inclusion

Bringing the unbanked into the financial mainstream is one of the principal advantages that a CBDC offers—particularly, as noted earlier, to less developed countries with large percentages of unbanked in their population.

A key feature of many retail CBDC projects is the ability of individuals to access a digital currency account offline as well as online.

“This is important as it effectively decouples financial inclusion from access to the internet,” says Laboure. Thus, people will be able to make CBDC transactions over basic mobile devices, using stored value cards, for example, or even text messages.

The financial inclusion benefit is not a given warns Perumall. “To lay claim to this feature, the system for a CBDC needs to be designed with inclusion in mind,” says Perumall. 

Offline access is one such design element, but there are more. For example,  the system must be interoperable with the diverse payment mechanisms used in an economy, and it must be accepted by merchants. It also requires simplified KYC (know-your-customer) and AML (anti-money laundering) processes.

Where the private sector fits in

Implicit in the above—and an altogether new departure in the history of banking—is the existence of a direct relationship between individual citizens and their country’s central bank, in which the former hold a CBDC account with the latter.

In some countries’ designs, citizens may use a mobile app to access that account directly, but it is more likely that private sector banks will play the role of intermediary in a two-tiered digital banking system.

There are nevertheless concerns that central banks could compete with retail banks for CBDC transactions, especially if the former opted to offer interest-bearing accounts. While not excluding that possibility, Perumall downplays disintermediation concerns.

“Private sector banks not only provide the mechanism for distribution of money into an economy,” Perumall says, “but they also provide the services and the management of such services that go along with it—things that no central bank has the capacity to do.”

Concerns also exist that CBDC accounts could exacerbate a banking crisis if customers began shifting funds from their retail banks to the safer haven of the central bank.

In Perumall’s view, however, the two-tiered system of most CBDC designs, along with non-interest-bearing accounts and limits on CBDC holdings, provide a safeguard of sorts against the possibility of bank runs.

Laboure similarly sees no CBDC threats to financial stability due to the same factors: their two-tiered design, zero interest accounts and caps on holdings. “Moreover, looking at countries where CBDCs are live, current adoption rates are low,” Laboure adds.

Preparing for the day

As the example of Singapore suggests, the possibility of an extended wait for the widescale introduction of retail CBDCs is real.

There is, after all, ample scepticism among politicians, and even some central bankers, about the very need for CBDCs.

“A solution in search of a problem?” is a recurring question about CBDCs asked in recent months and years by authoritative sources who posit the view that a digital currency offers more risk than reward.

Private sector banks should not, however, assume that launches will be delayed indefinitely. Singapore’s MAS, for one, has made clear that it could bring forward the launch of its digital currency if “innovative uses emerge or there are signs that digital currencies not denominated in [Singapore dollars] are gaining traction as a medium of exchange locally”.

Retail banks will need to make preparations. That means, for example, readying their technology systems to be able to process CBDC transactions at scale; creating electronic wallets or other end-user interfaces so their customers can begin making CBDC transactions; and developing ideas for new services associated with the management of CBDCs. It is not too early for banks to begin taking such steps.

Key Takeaways: 

• The widespread introduction of central bank digital currencies (CBDCs) in the world’s major economies.
• As of June 2023, 11 countries or their currency unions had fully launched digital currencies, 21 had embarked on pilots, 32 had them under development and another 46 were at earlier stages of researching them (data available in the article).
• With the exception of Nigeria, all of the 11 that have launched CBDCs thus far are small economies in the Caribbean region.
• Of the pilots, three are in Africa – Ghana, South Africa and Tunisia
• Principal advantages of CBDCs offers, retail CBDC key features and concerns.

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“While tax compliance in the crypto space has been a murky area until now, SARS and the South African Reserve Bank (SARB) have followed other international jurisdictions in developing stringent regulatory frameworks for this burgeoning segment of the market, with much focus on transparency,” Seccombe says.

Now, there is no longer any doubt that taxpayers are required to disclose their crypto assets – including purchases, current holdings and disposals – as part of their statements of assets and liabilities.

From a tax perspective, cryptocurrencies are not regarded as currencies, but rather as financial instruments. This means crypto holders will need to work out whether their purchases and disposals are treated as trades – the profits on which incur taxes of between 18% and 45% – or their holdings are considered investment assets, meaning capital gains taxes of between 7.2% and 18% would apply.

“Here, it’s important to note that in the digital currency space, there’s no minimum holding period for a crypto asset to be regarded as an investment,” Seccombe says.

For an asset to be regarded an investment for tax purposes, the taxpayer must be able to show that their main intention was not to ultimately sell it at a profit. This can be difficult to prove.

Using equities as an example, the taxpayer would need to show that a share in a company was bought mainly for the dividend income it would produce, with profits on disposal being a secondary goal. In the case of real estate, a property is considered an investment if the main intention of the purchase was for private use or to obtain rental income.

“The same logic applies to cryptocurrencies, and it’s hard to show that a Bitcoin purchase, for example, wasn’t mainly aimed at one day realising a trading profit,” Seccombe says.

“In the current crypto market downturn, taxpayers may be forgiven for celebrating the idea of trade losses. However, they should note that foreign trading losses cannot be used to offset South African income tax, while local trading losses will be immediately ring-fenced should the taxpayer be in the top tax bracket.”

If a taxpayer has objective proof that their crypto assets were bought mainly to diversity their investment portfolio, or that they are generating returns from those assets while holding them, then they will stand a reasonable chance of proving that those assets are held as investments. In this case, any disposals will be treated as capital gains or capital losses. Capital losses suffer none of the ring-fencing provisions that trading losses do.

Thankfully, the tax consequences associated with cryptocurrency mining are a great deal simpler.

Mined crypto assets are regarded as income from services rendered, which should be declared along with other income. Similarly, interest earned from crypto lending arrangements will bear all the same tax consequences as other local or foreign interest returns.

Importantly, it doesn’t matter whether returns from offshore crypto assets are repatriated back to South Africa or not. Either way, there’s a legal requirement that they be disclosed to SARS and taxed locally.

“Now that countries share financial information, crypto holders can no longer hope that SARS will never find out about foreign holdings. Should the tax service discover these assets – an increasingly likely outcome – they will need to pay the relevant taxes plus significant penalties and interest.”

Meanwhile, if cryptocurrencies are received in lieu of goods sold or services rendered, the market value of the crypto assets received in payment is taxed as if it was cash.

Things get more complicated when one cryptocurrency is exchanged for another – for instance, Bitcoin is exchanged for Ethereum.

In this case, to determine tax liabilities, the cost of the Bitcoin holding will be offset against the market value of the Ethereum. To complicate matters further, the cost of the Ethereum acquired via that swap will be considered the equivalent of the market value of the Bitcoin that was exchanged.

Finally, arbitrage trades – for example, purchasing Bitcoin on an offshore exchange and then selling it on a South African exchange – will also have tax consequences. Many of the prices involved will be stated in foreign currencies and must be translated into rands.

With all this in mind, cryptocurrency holders will need to maintain records of purchase costs, as these will determine tax liabilities once assets are sold.

Fortunately, the increased scrutiny on cryptocurrencies globally has prompted a number of companies to specialise in assisting taxpayers with obtaining this information – an example being Koinly.

“From a tax perspective, the cryptocurrency market is now much more complicated,” Seccombe says.

“Consulting a tax practitioner before assets that are undeclared or wrongly declared are picked up by SARS could be a worthwhile undertaking. Remember that should SARS discover prior transactions involving crypto assets, it can go back as many years as they choose and reassess the taxpayer, which could mean hefty penalties and interest.”

Disclaimer

Crypto assets are not yet regulated by the Financial Sector Conduct Authority (FSCA) or any other regulatory body in South Africa and financial advisors are not allowed to provide advice on crypto assets. There has however been progress as the FSCA as part of the Intergovernmental Fintech Working Group (IFWG) comprising of the National Treasury, South African Reserve Bank and Prudential Authority, Financial Intelligence Centre, National Credit Regulator and South African Revenue Services, published “The Draft Declaration of crypto assets” as a financial product under the Financial Advisory and Intermediary Services Act – which made a variety of recommendations pertaining to the regulation of crypto assets. Public comments are currently under consideration.

The fact that the FSCA has not yet regulated crypto assets does not mean that you don’t need to have your tax affairs in order. Therefore, independent investment advisory and wealth management firm, GraySwan, tasked Dianne Seccombe, National Head of Taxation at Mazars, to shed light on the declaration and taxation of crypto asset profits and losses.

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