Exploring Central Bank Digital Currency: The Future of Money

Ashley_Buckwell

Cryptocurrencies and stablecoins have grown in popularity in recent years, ushering in a new paradigm in which access to quick and low-cost payments and secure stores of value are available to anyone with an Internet connection. These new technologies are in direct competition with traditional banking instruments, and in an effort to stay relevant and retain their control over the monetary system, central banks have proposed their own new technologies. A central bank digital currency or CBDC is a virtual currency backed and issued by a central bank or government. This article delves into what CBDCs are and how they will affect our everyday lives.

What is digital currency, and more specifically, what is CBDC?

CBDCs are an innovation in the form of money issued as well as the underlying infrastructure on which payments can be transacted. A CBDC is a digital payment instrument, denominated in the national unit of account, that is a direct liability of the central bank. It is a country’s legal tender issued in a digital form as a medium of exchange, store of value, and unit of account. It is the same as the existing fiat currency and is exchangeable one-to-one with the fiat currency.

Currently, only commercial banks and certain permitted financial institutions can hold central bank money in the form of “reserves.” The retail public can hold only currency issued by banks as physical bank notes or digital entries in accounts. CBDCs have the potential to be widely used by everyone, including wholesale financial institutions, businesses, and households, to store value and make payments.

Differences between CBDCs and other digital currencies

It is easy to confuse a CBDC and cryptocurrency, but they are not the same. CBDCs are centralized and fall under the purview of a country’s central bank or treasury department. By contrast, cryptocurrencies are decentralized, without any governing body, giving users more control. Also, cryptocurrencies run on blockchains, meaning that multiple nodes all around the world, and not one central hub, are responsible for verifying transactions.

Difference between CBDCs and stablecoins

Stablecoins, which are a type of digital money and operate on decentralized blockchain networks, allow individuals anywhere in the world to transfer value denominated in a fiat currency quickly and cheaply without the limitations and censorship by government that we have come to normalize in recent decades. The value of a stablecoin is pegged to that of an existing currency. For example, USDT, the largest private stablecoin by market cap and transaction volume, is tied to the US dollar. One USDT equals one US dollar. Stablecoins were developed to overcome the challenges of the traditional banking system, which has been slow to take advantage of emerging technology and is particularly unsuited to transferring value over the Internet.

CBDCs were proposed as a response to the success of stablecoins. CBDCs issued by government-mandated financial institutions hold equal legal status as their fiat currency counterparts.

Pros of CBDCs

1. Improve interbank payment settlement. Through automation and centralized netting solutions, CBDC payments are settled instantly between counterparties on an individual order basis, reducing the risk of overnight batch processing and collateralization.
2. Reduce counterparty risk. CBDC mitigates credit risk in cross-border payment transactions by enabling payment-versus-payment settlement for transfers in different currencies.
3. Stay competitive. CBDCs enable a more streamlined and efficient banking infrastructure by bypassing many of the old, labor-intensive processes currently performed by financial institutions.
4. Simplification of monetary policy. Retail CBDCs would allow central banks to establish a direct connection with citizens. This direct financial connection opens up a range of policy options for expansionary (and contractionary) monetary policy. This could include instant transfers of helicopter money.
5. Financial inclusion. CBDCs will simplify the process of distributing and collecting funds by helping to facilitate government transactions, such as the issuance of benefits like universal basic income and the collection of taxes. 

Cons of CBDCs

1. Traceability. You will no longer transact anonymously, as has been possible with physical cash. CBDCs use a private ledger, offering traceability and transparency for central banks. In the same way that your debit card transactions are visible to your bank, your CBDC financial activity will be visible to your central bank and government.
2. Negative interest rates. Once physical cash is eliminated, your funds will be locked in to the CBDC system. This gives central banks greater flexibility to implement negative interest rates. In doing so, people will be encouraged to use the money or lose the money, increasing consumer spending.
3. Personalized monetary policy. The issues of traceability, absence of physical cash, and programmability raise the likelihood of personalized monetary policy. With a bank of Big Data on individual spending, saving, and investing habits coupled with digital identification infrastructure, central banks will have enough information to tailor their monetary policies. A government could segment its voters, identify communities where it is behind in polls, and deliver stimulus to these groups. 
4. Programmability. The major problem central banks encounter with current monetary stimulus policy is that although they control the price of money (interest rates), they do not control the velocity of money. CBDCs change that. Here are three examples of how that might work in practice:
   1. Expiration: With a direct relationship with your central bank, CBDCs could permit a currency expiration policy. Your money could be programmed so that if you do not spend the $5000 in your CBDC account by next Saturday, it will expire.
   2. Helicopter money: CBDCs are a means of delivering stimulus checks quickly and efficiently to citizens. With the push of a button, your newly printed fiat currency can arrive straight in your CBDC account. This is in contrast to traditional quantitative easing, in which the flow of currency relies to a greater extent on financial institutions. 
   3. Lending: With a diminishing role for commercial banks, central banks will play a greater role in lending decisions. Want a mortgage or business loan? Complete the application on your CBDC app, and the central bank will be in touch.

Which countries have adopted or are in the process of adopting a CBDC?

The potential of transformation and innovation of CBDCs has so far prompted 114 countries, representing more than 95 percent of global GDP, to start exploring the topic, with various projects at different stages of development, from research to proof of concept, pilot, or even deployment. The Atlantic Council has created an interactive world map detailing the current status of CBDC development in each country.

Here are a few of the major countries that are in advanced stages of CBDC development:

• China launched a pilot version of its digital currency, e-CNY, in April 2020 to select cities, merchants, and regions. Transactions using digital yuan exceeded 100 billion yuan ($13.9 billion) as of August 31, 2022.
• Israel, Sweden, and Norway have launched a project with the Bank of International Settlements to test linking their domestic CBDCs and to explore how CBDCs can be used for international retail and remittance payments.
• Nigeria launched its CBDC, eNaira, in October 2021. The eNaira facilitated transactions worth 4 billion naira ($9.3 million) in its first year of operation. Unfortunately, the naira has lost three quarters of its official value in the last seven years, and this has led to the introduction of gold coins and even calls to legalize bitcoin in the country.

Current US stance on CBDCs 

A US CBDC is in active development. The Federal Reserve has been exploring the potential benefits and risks of CBDCs from a variety of angles, including through technological research and experimentation, and many in the Biden administration have been actively working behind the scenes to advance a US CBDC. Furthermore, the problems that have arisen in the cryptocurrency market in the past year, including that of the fraudulent crypto exchange FTX that we wrote about here, have given voice to those calling for a more tightly regulated US digital currency landscape with CBDCs at the center. 

The move to low or no-cash economies based on CBDCs appears to be inevitable. How would all-digital currency affect our everyday lives? While CBDCs bring several advantages to our ability to transact, the implications of the lack of privacy and loss of individual control that result from their use remain to be seen and will become more apparent over time. 

 *The opinions reflected in this article are the sole opinions of the author and do not reflect any official positions or claims by Acer Inc.

About Ashley Buckwell: Ashley is a technology writer who is interested in computers and software development. He is also a fintech researcher and is fascinated with emerging trends in DeFi, blockchain, and bitcoin. He has been writing, editing, and creating content for the ESL industry in Asia for eight years, with a special focus on interactive, digital learning.