What you need to know about CBDC?

CBDC stands for “central bank digital currency”, a new type of currency that governments around the world are experimenting with. CBDC uses an electronic record or digital token to represent the virtual form of a fiat currency of a particular nation (or region). A CBDC is centralized, it is issued and regulated by the competent monetary authority of the country. What sets a CBDC apart from established currencies is that proponents hope it can use new payment technology, blockchain to potentially increase payment efficiency and lower costs.

Over the years, there has been growing interest in cryptocurrencies like Bitcoin and Ethereum, which work on a distributed ledger technology known as blockchain network. Such virtual currencies have gained immense popularity, owing to their decentralized and regulation-free nature. However, some see their rise as a possible threat to the traditional banking system that operates under the purview and control of a country’s regulatory authority, such as a central bank.

There is no clarity about any suitable reserve maintenance to back up the valuations of cryptocurrencies. Additionally, the continued launch of new cryptocurrencies has also raised concerns about the possibility of scams, thefts, and hacks.

Unable to control the growth and influence of such cryptocurrencies, many leading central banks across the globe are working on or contemplating launching their own versions of cryptocurrencies. These regulated cryptocurrencies are called central bank digital currencies and will be operated by the respective monetary authorities or central banks of a particular country.

Also called digital fiat currencies or digital base money, CBDC will act as a digital representation of a country’s fiat currency, and will be backed by a suitable amount of monetary reserves like gold or foreign currency reserves.

Each CBDC unit will act as a secure digital instrument equivalent to a paper bill and can be used as a mode of payment, a store of value, and an official unit of account. Like a paper-based currency note that carries a unique serial number, each CBDC unit will also be distinguishable to prevent imitation. Since it will be a part of the money supply controlled by the central bank, it will work alongside other forms of regulated money, like coins, bills, notes, and bonds.

CBDC aims to bring in the best of both worlds—the convenience and security of digital form like cryptocurrencies, and the regulated, reserved-backed money circulation of the traditional banking system. The particular central bank or other competent monetary authority of the country will be solely liable for its operations.

For institutional and retail payments, there is less transaction fee that you need to pay with CBDC. The production, storage, transportation, and disposal of Central Bank Digital Currency does not demand a massive amount of money. So, in terms of all these things, it is cheaper than cash. If you think about distribution, it is much safer, reducing the fraudulent activity in the payment ecosystem.

The Central Bank Digital Currency allows the Central Bank to offer liquidity assistance that is short-termed. Despite all the bank holidays, CBDC still works. In this way, the risk of triggering chain reactions of individual institutions is reduced systematically.

You don’t need to rely on any intermediaries for making a payment. Central Bank Digital Currency’s efficient technology allows you to do the financial payment settlement in real-time by improving its speed.

With the benefits and advantages that Central Bank Digital Currency is offering, it creates competition in the market for other banks and financial institutions. And to produce innovative solutions, private actors are needed here. This can lead to increased competition between several banks that attract the deposition of assets that otherwise might migrate to CBDC.

Some consumers may not have any bank account. Central Bank Digital Currency can give them an existing digital payment tool at a zero or minimal cost. In addition to it, CBDC also can be used as a direct monetary policy tool.

With the central banks becoming the active competitors for the payment service providers. Likewise, consumer deposit demand may be reduced as a result of a new investment opportunity. This will lead to lower economic growth.

As Central Bank Digital Currency totally depends on the internet’s availability, it is less reliable. If any electricity outages occur, this system will not work. This kind of money transaction requires a proper and speedy internet connection and can not be risked to the lousy network provider. All these reasons make it less reliable.

It increases the risk for systematic bank runs. In a financial crisis, these banks run with much faster potential without the barrier of geographical proximity and time. Additional compliances and monitoring can be required here as per the CFT or AML laws.

As it is the nearest substitute, it can encourage the banks to raise the rates of depositions. So, the commercial banks will face several challenges here.

Apart from all the four above-mentioned drawbacks, there are some limitations that Central Bank Digital Currency. Such as, only the issuer country can accept CBDCs, and none other can accept them. As the cryptocurrency shows a high level of volatility, this can be speculated.

To date, no country has officially launched a central bank-backed digital currency. Many central banks, however, have launched pilot programs and research projects aimed at determining a CBDC’s viability and usability.

The Bank of England (BOE) was the pioneer to initiate the CBDC proposal. Following that, central banks of other nations, like China’s People’s Bank of China (PBoC), Bank of Canada (BoC), and central banks of Uruguay, Thailand, Venezuela, Sweden, and Singapore, among others, are looking into the possibility of introducing a central bank-issued digital currency.

In April 2020, China became the first major economy to pilot a digital currency. The People’s Bank of China is aiming for increased domestic use of the digital yuan by the 2022 Winter Olympics in Beijing. Estimate that over RMB150 Million (US$23 million) of the digital yuan is in circulation. 

In 2017, as a part of a wider push to develop its high-technology sectors, China launched a project called Digital Currency/Electronic Payments, or “DC/EP.” Since then, Chinese officials have described the currency as having “controllable anonymity,” giving the government far-reaching powers to identify money laundering and other illicit activity. 

Chinese leaders may also seek to use the digital currency to reduce the country’s reliance on U.S. financial institutions and US government oversight. In April 2020, China piloted the digital currency in four cities, allowing commercial banks to run internal tests like conversions between cash and digital money, account-balance checks, and payments. In August the piloted program expanded to 28 major cities. By November 2020, the PBOC stated the digital currency in circulation had been part of more than 4 million separate transactions which have a total value of more than RMB 2 billion (US$299 million). Over RMB 150 million (US$23 million) of DC/EP is in circulation. 

The PBOC has begun laying the groundwork for digital currency to be used in cross-border transactions. Aiming for broad circulation in 2022, the People’s Bank of China and the Hong Kong Monetary Authority have begun ‘technical testing’ for cross-border use of the digital yuan as of April 2021 and plan to test it with foreign visitors at the 2022 Beijing Winter Olympics. This is in addition to a separate announcement they made in February 2021 that the PBOC joined central banks from Thailand, the United Arab Emirates, and Hong Kong to explore a digital currency cross-border payment project together.

The United States lags behind in its own research. However, both Fed Chair Jerome Powell and Secretary Janet Yellen have recently signaled that the US may start moving faster on a digital dollar.

Source : Atlantic Council CBDC Tracker (as at 18th May 2021)

Given the ongoing pilots and the considerable attention and effort that central banks are dedicating to CBDCs, it is clear that they will become a reality soon. So, the world must be ready to cope.

As it is now a given that we will see a growth of private and public “regulated” digital currency initiatives, we anticipate that CBDCs will be deployed in the world economy within a horizon of two to three years.

The introduction of CBDCs will be a game changer, promoting payment efficiency and representing an additional alternative to the current money model from an operational and technological point of view. The implementation of a successful CBDC model should ideally be seamless and not disrupt the customer’s experience.