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CENTRAL BANK DIGITAL CURRENCY: IS IT THE RIGHT CRYPTOCURRENCY?

Introduction:

Central Bank Digital Currency CBDC may be the right cryptocurrency of the future. We hereby shed light on various aspects of CBDC including key features and uses, historical evolution and regulation, technology design and infrastructure, challenges and opportunities, and world spread. We conclude with a future outlook and the way forward.

CBDC KEY FEATURES:

Central Bank Digital Currency CBDC is a digital currency issued by a central bank. It is a new form of central bank money. Central Bank Digital Currencies are also called digital fiat currencies or digital base money.

CBDC is inspired by bitcoin, but is different in various respects. While Bitcoin is not issued by a state and lack the legal tender status declared by the government, CBDC is issued and backed by a central bank in a country. More than 80% of central banks around the world have interest to issue their CBDC.

Key features and uses of CBDC are:

  • Digital banknote: a CBDC is like a digital banknote. It could be used by individuals to pay businesses and shops. It can also be used between financial institutions to settle trades in financial markets.
  • A third form of central bank money: Central bank money traditionally takes two forms. These are cash and reserves held by eligible financial institutions at the central bank. CBDC is a third version of currency that use an electronic record or digital token to represent the digital form of a nation’s currency. CBDC is issued and managed directly by the central bank and can be used for a variety of purposes by individuals, businesses, and financial institutions.

HISTORICAL EVOLUTION AND REGULATION

The concept of digital currency dates back to long decades. We hereby trace the evolution of various forms of digital currency:

  • Bitcoin: launched in 2009, is recognized as the first privately issued, decentralized (ledger-based), and encrypted digital currency or cryptocurrency. Today, there are an estimated 7,000 distinct cryptocurrencies. Since their introduction, cryptocurrencies have been characterized by extreme price volatility. Cryptocurrency has primarily served as a speculative investment, with more limited use as a medium of exchange.
  • Stablecoins: Private sector digital tokens, backed by fiat government-issued currency held in physical reserves, were first introduced in 2014 and designed to address the extreme volatility of ledger-based cryptocurrency. However, like cryptocurrency, stablecoins are privately issued and neither regulated nor backed by a monetary authority.
  • Central Bank Digital Currency CBDC or digital cash: CBDC is issued by a central bank, and the holder of CBDC has a direct claim on the state. This preserves the concept of money as a public good and makes CBDC a safe store of value, but it also has the potential to disintermediate banks and undermine financial sector stability if individuals and companies are able to hold accounts directly at the central bank.

The European Central Banks and various central banks and monetary authorities around the world are working on CBDC regulations. These regulations address various issues including:

  • Users rights
  • Credit operations
  • Capital adequacy
  • Monetary policy
  • Money Laundering
  • Privacy
  • Availability in markets

U.S. officials are evaluating the ability of CBDC to improve domestic and global payment systems.  The European Central Bank ECB is investigating the potential for a digital euro to enable the digital economy and support European sovereignty and stability.

 CDBC Technology DESIGN AND INFRASTRUCTURE

Key CBDC technology design and features include:

  • Electronic record: CBDC uses an electronic record or digital token to represent the virtual form of a fiat currency of a particular country.
  • Centralisation: CBDC is centralized. It is issued and regulated by a central bank or a monetary authority in a country.
  • Reserve back up: CBDC is the liability of the central bank, which means that the government must maintain reserves and deposits to back it up.
  • Electronic cash: CBDC is essentially electronic cash. Like traditional cash, CBDC gives holders a direct claim on the central bank and allow businesses and individuals to make electronic payments and transfers.
  • Risk: CBDC differs from a debit and a credit card. Debit or credit cards are considered as one form of digital money but they are issued by commercial banks, based on central bank money credited electronically to customers’ accounts. Debit and credit cards entail default risk as commercial banks may fail and governments usually only insure a certain amount. However, CDBC is fully backed by central banks and is default-risk free.
  • Uses: CBDCs are built for either retail or wholesale payments. Retail CBDCs are used in the same manner as banknotes, to make payments between individuals, or between individuals and businesses. Wholesale CBDCs are used to enable transactions between financial institutions and entities that have accounts in central banks.

BIS identifies a list of foundational design choices for CBDC:

  • Architecture: refers to the operational role and division of responsibilities between the central bank and private intermediaries.
  • Infrastructure: refers to the technical design and choice between a centralized database or decentralized Distributed Ledger Technologies DLT for recording transactions in CBDC.
  • Access: defines whether CBDC use is based on individual identity or anonymous through digital tokens.
  • Financial intermediation: defines the role of banks and credit allocation decisions with the state.
  • Payment and settlement platforms: are platforms on which a CBDC can operate. Platforms should be interoperable with one another and with legacy systems.
  • Global trade platforms: are platforms for domestic and global payments across borders.

CBDC CHALLENGES AND OPPORTUNITIES

CBDC supports the digital economy with access to the safest form of money, a claim on a central bank. This promotes diversity in payment options, make cross-border payments faster and cheaper, increase financial inclusion and facilitate fund transfers.

CBDC overcomes the threat of cryptocurrency like bitcoin because it operates under the control of a country’s regulatory authority, such as a central bank. Hence, CBDCs can be more broadly accepted by the general population because they are subject to legal and government regulations.

CBDC benefits include:

  • Allowing real-time monitoring and analytics of all the finances running through the central bank.
  • Enhancing the efficiency of central banking systems.
  • Enabling faster and easier transactions.
  • Reducing costs of financial services by eliminating physical cash distribution and destruction from circulation.
  • fostering financial inclusion, those who are unbanked can get easier and safer access to money on their phone.
  • Improving transparency standards and limit illicit activity.
  • Ensuring quicker flow of monetary policy.
  • Reducing the dependency on foreign currency like US dollars.

CBDC risks include:

  • Run on banks: Citizens could pull too much money out of banks at once and purchase CBDCs, triggering a run on banks.
  • Cybersecurity risks: centralizing through the government a system designed to be private may produce a backlash among users and create cybersecurity risks.
  • Lack of supporting regulation: countries regulatory processes are not always updated to deal with new forms of digital money.
  • Difficulty in Tracking cross border trade: United States is able to monitor and regulate most digital payment flows in dollars all over the world. But new payment systems could limit the ability of policymakers to track cross-border flows.
  • Widespread adoption challenges: Increased digitalization may leave a portion of society behind due to potential barriers around trust and data privacy, digital knowledge, and access to Information Technology.

Central banks are interested in CBDC for many reasons:

  • Central banks fear losing control over the supply of money and payments systems to cryptocurrencies, such as Bitcoin or even the planned Facebook-backed cryptocurrency Diem.
  • The spread of forms of payment not overseen by any central or public body could weaken central banks grip on the supply of money, and economic stability. This threat has grown even deeper as cryptocurrencies are increasingly embraced. CBDC help central banks in addressing this threat.
  • CBDC ensures that the public has access to central bank money.
  • CBDC offers a new tool for central banks to transmit monetary policy and keep economies stable.

cbdc around the world

Interest in CBDC has grown in response to changes in payments, finance and technology. It was accelerated by the Covid-19 pandemic. Pioneers in launching a CBDC initiative are the Bank of England, People’s Bank of China (PBoC), Bank of Canada, and central banks of Uruguay, Thailand, Venezuela, Sweden, and Singapore. Other nations are looking into the possibility of introducing a central bank-issued digital currency. Russia has been moving forward with its creation of the crypto-ruble. China aims to become the first major central bank to issue a CBDC. The European Central Bank is exploring the launch of a digital euro. The Bank of England has stepped up research in Bitcoin and is directed to CBDC research.

Trade regions like the Middle-East are uniquely positioned to take advantage of CBDC as energy and global trade trends shift. Kuwait, Oman, Saudi Arabia, UAE, Iran and other Middle Eastern countries have long relied on energy resources for economic growth. However, the global demand for oil may reduce over the long term as global mandates for greener energy are introduced. The central banks from both Saudi Arabia and UAE have both been collaborating on blockchain and cryptocurrency technology projects in the financial sector. Six commercial banks made up of three from each country participated in a joint CBDC project called Aber. The Saudi Central Bank and the Central Bank of UAE foresee that a dual-issued CBDC would be technically viable for cross border payments, as it would be an improvement over current centralised payment systems, like SWIFT. Aber project results show that the distributed ledger technology would enable central banks to develop new payment systems.

The United States Digital Dollar Project is launching five pilot programs to test the potential uses of a US central bank digital currency.

The online CBDCTEACKER https://cbdctracker.org/ provides a useful visual tool to track CBDC by country on the world map. The dashboard visualises research pilot, development, and launched CBDC initiatives around the world and presents a tabulated listing of results.

future outlook and way forward

The advent of new technologies and the evolution of information systems has strongly shaken the banking and financial ecosystem. Digital currencies and payment instruments including cryptocurrencies, global stable-coins, and CBDC have emerged as important innovations with potentially large impacts on the international monetary and financial system.

CBDC promises increased efficiency and lower costs, improved access to financial services, and greater transparency and accountability in payment systems and financial flows. It also raises new risks and greater technical and regulatory complexity. CBDC are unlikely to overtake cryptocurrencies due to their limited supply.  

CBDC may become a reality soon. It may help boost crypto adoption as people will have access to the platforms to convert cryptocurrencies into legal tenders. It will also help in accelerating financial inclusion.

The way forward is to enhance CBDC regulation, design, and architecture as follows:

  • Regulation: CBDCs will have far-reaching implications on the future of finance, including the buying and selling of digital assets and securities. However, this relies on the foundations of a dedicated legal framework to facilitate the transparency, distribution, and issuance of a digital form of money by global governments. As regulators and central banks take concrete steps in the direction of establishing CBDCs, the world will begin to embrace digital currencies as a standard.
  • Design: CBDC design elements depend on individual country preferences. International cooperation on data frameworks, privacy protections, and technical interoperability are necessary to fully realize the benefits of CBDC, especially for cross-border payments. Multilateral agreement and CDBC standards will take time, but national authorities can act now to ensure an enabling domestic environment for CBDC and other digital currency developments
  • Architecture: establishing the architecture, infrastructure, and rules for access to CBDC will entail design choices that are not without trade-offs. Priorities for national authorities include establishing data frameworks as well as digital identity.

 

REFERENCES

Wikipedia, BIS, Investopedia, Atlantic Council, CBDC Tracker, Bank of England, Board of governors of the federal reserve system, Financial Times, PwC, CSIS Center For Strategies and International Studies, Finextra, Arabian Business, Reuters, AI Multiple, Hedera, American Express, COLUMBIA LAW SCHOOL’S BLOG ON CORPORATIONS AND THE CAPITAL MARKETS.

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