What are CBDCs?
The CBDCs or Central Bank Digital Currency is a country’s recognized currency in electronic form. They give holders a direct claim on the Central Bank and let businesses and individuals make electronic payments and transfers.
Ingress to Central Bank money beyond physical cash has been so far restricted to financial institutions.
Cryptocurrencies are not yet ready for mainstream retail due to their lack of regulation, rampant volatility and it is an extraordinary risk. All these are good speculations but bad for e-commerce merchants.
The governments worldwide are considering CBDCs as the cryptocurrencies are aiming at bringing stability and avoiding financial crisis if crypto speculation bursts bubbles.
In the future, digital currencies with a distinctive serial number could replace paper and coins. A digital currency could be acceptable for all transactions such as loans, salaries, investments, and retail payments.
Digital currencies will also represent the convenience and the regulation of the endurance of a reserved-backed money supply.
CBDCs holders could have digital wallets like smartphones. Bank accounts would seemingly remain more or less the same. A digital dollar in a savings account would look similar to paper dollars stored in those accounts. Hence, the value of a digital dollar would be equal to that of the traditional currency. Meaning the value of cryptocurrency will no longer be based on speculation and hype.
Why the Central Bank interest in Cryptocurrency
The Central Bank has the fear of losing control over the supply of money and payment systems to cryptocurrencies like the facebook-backed cryptocurrency Diem and Bitcoin. Any form of payment not overseen by the Central Bank or any public body would tend to weaken Central Bank’s economic stability and its grip on the supply of money. The threat is growing deeper every day as cryptocurrency is being embraced even more every day.
The use of less physical Cash is also another reason why the Central Bank would be interested in cryptocurrency. The Central Bank would ensure that the public has access to Central Bank money.
The cryptocurrency would also offer a new tool for the Central Bank to transmit monetary policy and keep economies stable.
CBDCs are unlikely to take over cryptocurrency due to their progressively limited supply. Anatoly Crachilov, co-founder and CEO of Nickel Digital Asset Management, told Reuters Global Market Forum.
No Central Bank at this stage can offer scarcity as its supply can be inflated by a respective Central Bank issuing entity.
Why the creation of CBDCs
Here are some justifications by monetary policymakers for creating CBCDs:
Prevention of international financial crisis
In Europe and North America, private investors own most of the cryptocurrency. Digital currencies are managed by technology companies, namely Alipay and WeChat Pay in China. If one of the main cryptocurrencies were to fail, a financial crisis would arise. Governments are now apprehending that CBDCs can offer the benefits of cryptocurrencies and e-payments without the risk of a worldwide financial crisis.
Convenience in an online world
Coins, cash, and credit cards are expensive to manage and store. The escalation of real-time payments shows that customers and businesses require simple, inexpensive, and secure ways of moving money. CBCDs would make real-time payments more accessible and reduce the load of handling cash.
Innovators and investors understand the lack of pervasion and stability hinders cryptocurrencies’ widespread adoption. No one would want to download a bitcoin online application without being sure of its future. A firm, government-backed digital currency would encourage payment and financial innovation.
Financial inclusion and fairness
According to advocates, Central Bank Digital Currencies would allow fair access to financial services mostly for the underbanked and the unbanked. Although, it is difficult to prove this point. Some advocates believe that a digital dollar would not need bank accounts and credit scores. But, it would demand modern, expensive access to high-speed internet and smartphones.
Prevent crime and protect privacy
Card-based payments are not private, whereas, cash payments are. Someone is always watching and tracking your transactions every time a payment is made using a credit card. CBDCs payments would be anonymous or semi-anonymous only if the government allows. Similar to cash payments, merchants, credit card companies, and financial institutions would not know who is paying. The government would still monitor the use of CBDCs to prevent money laundering and financial crime.
Countries leading in using CBDCs
China is aiming at becoming the first major Central Bank to issue a CBDC. Its work is to advance the internationalization of the Yuan. States banks are promoting the Yuan.
The European Central Bank is scouting the launch within five years of a digital Euro. The Bank of England is investigating what has been dubbed without making any firm commitments.
The US Federal Reserve is not in a rush for any digital dollar. Jerome Powell, the Chief of the Federal Reserve this year will be important in getting the ball rolling.
Smaller Central Banks like the Bahamas and the Eastern Caribbean are also active. In the year 2020, the first nation to introduce a CBDC nationwide. In April this year, the Eastern Caribbean become the first currency union Central Bank to issue digital currency.
Some risks of CBDCs
With all said and done, CBCDs has lots of potential for good but they could create a few problems like:
A strong, affordable, and reliable internet connection is vital to operate any CBDC system. Such internet access is not readily available to everyone, hence hindering the widespread adoption of CBDCs.
With CBDCs, the authoritarian government could have unequal access to an individual’s transaction data.
In the anticipated event of cyber attacks or honest mistakes, there is no guarantee of consumer protection. CBDCs promoters do not address real-world occurrences like chargebacks, refunds, and errors.
Any mass migration to a CBDC would deprive commercial banks of a cheap and solid source of funding. Commercial banks in Sweden fear that the availability of mortgages would become highly dependent on the Central Bank’s appetite for risk.
In case of an economic crisis, investors would withdraw their money but the CBCDs would plan to counter this by putting a cap on the holdings.
How CBDCs would look like
A CBCD would take the appearance of a token saved on the smartphone or a prepaid card. It could also exist in an account directly controlled by an intermediary Bank or a Central Bank. Nothing to it says that it should be a technology that powers cryptocurrency that is called a Blockchain.
Sweden’s e-krona, is currently on the testing phase and is based on Blockchain while People’s Bank of China said its digital Yuan would not rely on blockchain.
CBDCs have the potential to increase speed, transparency and efficiency especially in cross-border payments.
Central Banks around the world are considering the CBDCs and some are even making early and tentative steps toward making them a reality.
There are a lot of inter-bank discussions about the multitude practicalities the CBDCs involve.
CBCDs would work best as a two tier system where the Central Bank and the private sector would work together to do what each does perfectly. The private sector would innovate and serve customers whereas the Central Bank would operate the system’s core by making sure its safe and efficient.
Find out more by joining our Telegram community.