• Arjuna Gomatam

The Evolution and Adoption of CBDCs


What is a CBDC?


A Central Bank Digital Currency (CBDC) is the digital form of a fiat currency (a government-issued currency backed by the central bank) based on blockchain technology. It can most easily be understood as a hybrid of Bitcoin, the original cryptocurrency, and a government-issued currency. A CBDC aims to incorporate the best of both worlds.



Digital Ledger Technology (a.k.a Permissioned Blockchain)


Banks store your financial records on a ledger. In the case of a permissioned blockchain, the ledger will be composed of multiple copies of the transactions, each stored and managed by a separate entity. This is known as a permissioned blockchain since only particular entities can access the blockchain. This contrasts with private cryptocurrencies like Bitcoin and Ethereum, where no central entity has access to the ledger.


Governments would prefer introducing a CBDC over private cryptocurrencies for two main reasons:


Supply

The central bank will be able to change the supply of the CBDC as and when they feel necessary, in conjunction with the monetary policy, in contrast to a private cryptocurrency like Bitcoin, which has a limit of 21 million Bitcoins.


Access to the Digital Ledger

The ability of central banks to monitor the financial records will enable them to regulate any illegal transactions or transactions which pose a threat to national security.


Lower Costs and Higher Efficiency

The use of a CBDC would make payments faster, bypassing the obstacles of payment and settlement delays. In addition to this, it would lower the costs of transferring money. With a digital ledger, financial entities would be more connected, paving the path for a smoother and easier way to move money around as compared to the financial system that is in place today.


Issuing a digital currency would also make it easier for the government to deliver stimulus checks and target those most in need.



How Soon Could CBDCs be a Reality?


In an interview with CNBC, Benoit Coeure, Head, Innovation Hub at the Bank for International Settlements, said:

“When you ask central banks around the world whether they are exploring CBDC, one year ago [2020] the answer was: 80% of them are exploring. Now it’s nearly 90%. Last year, 40% were experimenting and now it’s 60%.”

China is currently the most advanced major economy with respect to a digital currency. The People’s Bank of China has been running tests with the E-Yuan since April 2020. Tens of thousands of consumers have already been involved with the pilot, with around 2 billion Yuan having been spent in over 4 million transactions.


The European Central Bank has plans for a digital Euro too. However, it has been implied that it will be a few years before it will be made available to the public. The president of the European Central Bank, Christine Lagarde, has emphasized that taking into account all of the ethical and security considerations, it will be “two, three, four years before it [the digital Euro] will be launched.”


The apprehensions and concerns of various governments with regards to a digital currency are valid. Before launching a CBDC, issues of anti-money laundering, financing of terrorism, and the privacy of users will have to be taken into account.


In addition to this, most governments see CBDCs as supplements to their fiat currencies. In extreme situations, such as after a recession, people may withdraw all of their money from commercial banks and store it in the CBDC. If savers shift all of their savings to the digital currency, then banks throughout the country will face issues with funding. This in turn will result in larger financial repercussions for the whole economy.


However, with the rise in popularity and value of private cryptocurrencies in the last year, there is no doubt that governments all over the world are thinking of ways to evolve and digitize the financial system. The question central banks now face is, if we can’t beat them, do we join them?


 

References:


Hertig, Alyssa. “What Is a CBDC?” CoinDesk, CoinDesk, 22 Dec. 2020, www.coindesk.com/what-is-a-cbdc


Online, FE. “What's in Store for Crypto Investors? Find Out.” The Financial Express, The Financial Express, 20 Feb. 2021, www.financialexpress.com/money/whats-in-store-for-crypto-investors-find-out/2198586/


Seth, Shobhit. “Central Bank Digital Currency (CBDC) Definition.” Investopedia, Investopedia, 13 Nov. 2020, www.investopedia.com/terms/c/central-bank-digital-currency-cbdc.asp


“Why Central Banks Want to Launch Digital Currencies: CNBC Reports.” YouTube, 11 Feb. 2021, youtu.be/Qrx_FnjRnfI

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