CBDC: A Global Phenomenon

CBDC A Global Phenomenon

A Central Bank Digital Currency (CBDC) is the digital equivalent of a national (fiat) currency that is issued and backed by the central bank. It is a new form of currency that is designed to be used in digital transactions, and it is backed by the full faith and credit of the issuing country’s government.

Unlike cryptocurrencies, CBDCs are fully backed by the central bank and have legal tender status. This means that they can be used to settle debts and taxes, just like traditional fiat currencies.

CBDCs have gained significant attention from central banks worldwide due to the potential benefits they offer. One of the biggest advantages of CBDCs is increased efficiency. CBDCs can be sent and received instantly, 24/7, without the need for intermediaries. This means that transactions can be settled much faster and at a lower cost than traditional payment systems. For example, “traditional” cross-border payments can take days to settle and incur high fees, but with CBDCs, these transactions can be settled instantly and at a much lower cost.

Another reason given for the consideration of CBDCs is financial inclusion. CBDCs can help to include unbanked and underbanked populations in the formal financial systems, as they can be accessed using a mobile phone or other digital devices, assuming that everybody owns a digital mobile device or physical wallet capable of storing CBDC. This can help to increase financial inclusion for those who meet these conditions and reduce the number of people who are excluded from the benefits of the formal financial system.

CBDCs can also help to reduce risks associated with traditional fiat currencies, such as counterfeiting, money laundering, and fraud. This is because CBDC transactions can be tracked and monitored much more easily than traditional fiat currency transactions. In addition, CBDCs can be designed to have built-in security features that make them much harder to counterfeit.

Finally, CBDCs can help central banks to implement monetary policy more effectively. They can provide a new tool for managing the money supply and interest rates. For example, a central bank could use a CBDC to provide direct stimulus payments to households during an economic downturn, rather than relying on traditional monetary policy tools such as interest rate cuts.

Types of CBDCs

CBDCs are generally classified into two types: retail CBDCs and wholesale CBDCs. Retail CBDCs are designed for general use by individuals and small businesses, while wholesale CBDCs are meant for financial institutions, governments and large corporations to settle transactions and execute payments.

Wholesale CBDCs

These are CBDCs that are only available to financial institutions and are used for interbank transactions and settlement. Wholesale CBDCs can help to improve the efficiency and security of the existing financial system by reducing the time and cost of settling interbank transactions.

Retail CBDCs

These are CBDCs that are available to the general public and can be used for everyday transactions. Retail CBDCs can help to increase financial inclusion by providing a digital payment option for people who may not have access to traditional banking services. They can also help to reduce the costs and risks associated with cash-based transactions.

Why are CBDCs being considered?

CBDCs are being considered by many central banks around the world for six primary reasons:

Efficiency

CBDCs are more efficient than traditional fiat currencies when it comes to transaction processing , as they can be sent and received instantly, 24/7, without the need for intermediaries, such as banks. This means that transactions can be settled much faster and at a lower cost than traditional payment systems. For example, cross-border payments can take days to settle and can incur high fees, but with CBDCs, these transactions can be settled instantly and at a much lower cost.

Financial Inclusion

CBDCs can help to include unbanked and underbanked populations in the formal financial system, as they can be accessed using a mobile phone or other mobile digital devices. This can help to increase financial inclusion and reduce the number of people who are excluded from the benefits of the formal financial system.

Retail CBDCs

CBDCs can help to reduce risks associated with traditional fiat currencies, such as counterfeiting, money laundering, and fraud. This is because CBDC transactions can be tracked and monitored much more easily than traditional fiat currency transactions. In addition, CBDCs can be designed to have built-in security features that make them much harder to counterfeit.

Monetary Policy

CBDCs can help central banks to implement monetary policy more effectively, as they can provide a new tool for managing the money supply and interest rates. For example, a central bank could use a CBDC to provide direct stimulus payments to households during an economic downturn, rather than relying on traditional monetary policy tools such as interest rate cuts.

Explicit Guarantee

CBDCs are a liability of the central bank to its depositors. Hence, it implies an explicit guarantee of the central bank to its depositors and make CBDC very safe under normal economic and business conditions, if we exclude any deliberate intervention of the state to control such deposits for political reasons.

Money Supply

CBDC would be 100% controlled by the central bank and would make it much easier to control the actual money supply to an economy and provide more accurate data of the money in circulation. It would also reduce or eliminate the legacy banks ability to create money out of thin air.

Real-time Analysis

CBDC will provide real-time insight and a better visibility of economic activity in a country. If all monetary transactions are being monitored by a central bank and the data can be considered as correct the management of the money supply and economic activities will be more accurate and adjustments can be made instantaneously, if needed.

Currently, policymakers trying to understand the economic activity in a certain sector or region must rely on estimates or outdated data, because it takes time to consolidate data, and get it aggregated, cleaned, transformed, analysed, and presented in a digestible format. In addition the data might have been compromised along the way.

CBDC & Financial Inclusion

A recent IMF paper titled “Central Bank Digital Currency and Financial Inclusion” modelled the impact CBDC could have on financial inclusion. The paper focused on two aspects of financial inclusion:

Bank deposits increase through deposits from the unbanked segment
Building up creditworthiness profiles for the unbanked segment

The paper concluded that, in a 2-tiered model, with the central bank issuing CBDC to commercial banks for distribution to the public, assuming a new bank account has been opened, the number of unbanked will decrease, and the banks will be able to gather enough spending data to help them build their credit to obtain non-consumption loans, and which may help them to strengthen their finances or start a small business.

Even in a model where a bank account is not needed, and payment service providers (PSP) distribute the CBDCs, by consenting to providing the CBDC usage data, the central bank and PSP will still be able to gather enough data to help build their credit profile.

The paper concluded that while CBDCs will help with financial inclusion, a greater benefit can be seen if this is done in concert with public policies and private sector initiatives.

Implementation

The implementation of a CBDC would require a significant overhaul of the existing financial system. The issuing central bank would need to ensure that the CBDC is secure, reliable, and accessible to all users. In addition, the central bank must decide on the role legacy financial services providers should play and how centralised and interoperable with legacy payment systems the new CBDC infrastructure should be. For a less centralised approach the central bank would need to work with other financial institutions and stakeholders to ensure that the CBDC is interoperable with existing payment systems. This would require significant coordination and investment in new infrastructure and technology.

CBDC Projects around the world

Many central banks around the world are currently exploring the potential of CBDCs. Some examples of CBDC projects around the world include:

China: The People’s Bank of China has been testing a digital version of the yuan since 2014. The digital yuan is currently being tested in several cities across China and is expected to be rolled out nationwide in the near future.
Sweden: The Riksbank, Sweden’s central bank, has been testing an e-krona since 2017. The e-krona is currently in the pilot phase and is being tested in a limited number of scenarios.
Bahamas: The Central Bank of the Bahamas launched the Sand Dollar, a digital version of the Bahamian dollar, in 2020. The Sand Dollar is currently in use in several pilot programs across the Bahamas.
European Union: The European Central Bank has been exploring the possibility of a digital euro since 2019. The ECB recently launched a public consultation to gather feedback on the potential design and implementation of a digital euro.
United States: The US has also been exploring the possibility of a digital USD in recent years.. The FED launched several research programs to gather feedback on the potential design and implementation of a digital USD.

CBDC Adoption

As of now, a large number of central banks are exploring the potential of CBDCs, and some have already launched pilot programs. The adoption of CBDCs would require significant changes in the existing financial systems, and central banks need to ensure that they are secure, reliable, and accessible to all users.

One of the largest economies in the world, China, has been exploring and testing the digital yuan since 2014. The digital yuan is currently being tested in several cities across China and is expected to be rolled out nationwide in the near future. The Central Bank of the Bahamas launched the Sand Dollar, a digital version of the Bahamian dollar, in 2020. The Sand Dollar is currently in use in several pilot programs across the Bahamas.

The European Central Bank has also been exploring the possibility of a digital euro since 2019. The ECB recently launched a public consultation to gather feedback on the potential design and implementation of a digital euro. The US FED and other central banks around the globe are in an additional phase. Sign up to Chavanette CBDC & Financial Services Technology Tracker if you want to always have access to the latest information.

Future of CBDCs

CBDCs have the potential to revolutionize the way we think about money and payments. They offer numerous benefits, such as increased efficiency, financial inclusion, reduced risks, and improved monetary policy. However, there are also significant challenges that must be overcome, such as ensuring security, reliability, and interoperability with existing payment systems. There is also the risk of abuse by rouge governments which could utilise CBDC to defund opposing voice and their access to the financial system.

As the world becomes increasingly digital, it is likely that more central banks will explore the potential of CBDCs. The adoption of CBDCs could lead to a more efficient and inclusive financial system, but it will require significant changes and investments in technology and infrastructure.

Conclusion

While there are many potential benefits to CBDCs, there are also potential dangers and misuses of this powerful invention that must be overcome. These challenges include ensuring the security and reliability of CBDC usage at all times, coordinating with other financial institutions and stakeholders, and investing in new infrastructure and technology. Therefore, it is important for all stakeholders to carefully consider the potential benefits and risks of CBDCs before moving forward with their implementation.