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The Rise of Central Bank Digital Currencies (CBDCs): Implications for the Future of Money

CBDCs or Central Bank Digital Currencies are tokenized forms of fiat currencies issued by governments. 

According to the IMF, CBDCs have conceptually existed for 30 years since the Bank of Finland launched its Avant smart card in 1993. Though this system was dropped by the turn of the century, it’s still widely considered the first CBDC.

Blockchain’s rising popularity has led to a resurgence of the concept, with over 100 countries researching CBDCs. A handful of countries have announced pilot programs, and some have even launched CBDCs for public use.

From increased capital efficiency to greater financial inclusivity, CBDCs could bring myriad benefits. However, there’s still much uncertainty surrounding blockchain, and more research needs to be done before CBDCs can be rolled out to the mainstream.

What are CBDCs?

CBDCs are digital forms of cash issued by central banks using blockchain. Most countries working on CBDCs are still experimenting, so there’s no concrete framework for implementing them globally yet.

A study from the Bank for International Settlements (BIS) shows that most CBDC projects have a domestic focus and do not aim to replace cash but instead want to create a digital complement.

CBDCs could bring many benefits, like greater resilience for domestic payments, improved accessibility, lower costs, and increased money flow transparency. However, they could also pose some serious risks.

If too much money is withdrawn from banks to purchase CBDCs, crises could ensue. The most active CBDC projects today do not offer interest on deposits and have all placed limits to prevent sudden outflows of bank deposits. 

Why do banks care about blockchain?

Over the last few years, there’s been a marked decline in the use of physical cash, spurring governments, banks, and other financial institutions to figure out best to take advantage of the digital revolution.

Between 2014 and 2021, the use of physical cash in Europe dropped by over 30%, with just 3% of transactions in Norway being conducted through non-digital channels. Digital assets could compete with fiat currencies as a unit of measure, especially with the number of people holding cryptocurrencies rising over time.

With the ever-increasing demand for international payments, central banks are looking for more localized control of global payment systems, and CBDCs might be the solution they need.

Whether or not CBDCs become more prevalent, banks are gearing up to harness emerging technologies. Designed well, CBDCs could be a significant milestone for the evolution of global money.

Who is working on CBDCs?

The most well-known and actively developed CBDC project comes from China. e-CNY, or the digital renminbi, is currently used by over 100 million individuals to process billions of yuan.

The Bahamas has also been working on a CBDC for some time now, having launched its Sand Dollar in 2021, while Riksbank, Sweden’s central bank, developed a proof of concept and is exploring the policy implications of introducing CBDCs. 

Though nearly a hundred countries are experimenting with CBDCs, designing one that doesn’t introduce unmanageable risks will take time, resources, and international collaboration.

What are the potential benefits and risks of CBDCs?

One of the biggest benefits CBDCs could bring is reduced costs. McKinsey claims they could save financial service providers up to $400 billion annually. However, these figures must be against the cost of integrating the technology. 

CBDCs also offer increased security, minimizing fraud and wait times for transaction finality. However, the notion that blockchain payments are faster is constantly being challenged, with many countries offering instant payments using centralized infrastructure.

Another benefit is inclusivity – 5% of adults in the US, and over 1.6 billion people worldwide, do not have access to banking services. Digital assets can be used with any Internet-connected smartphone, enabling financial service providers to access prohibitively expensive markets.

In 2021, the Eastern Caribbean Central Bank used its CBDC pilot, DCash, to aid victims of areas affected by a volcano eruption. However, though blockchain technology has existed for over a decade, it’s still in its infancy, and technological instability is a big concern. Just last January, DCash went down for two months due to technical difficulties.

Notably, some of the unbanked population are avoiding banks intentionally, and CBDCs are unlikely to sway them away from the anonymity of physical cash. This might not sound like a big deal, but digital money is traceable, making voluntary adoption a more significant hurdle than seems obvious. 

Preparing for a CBDC-enabled world

CBDCs sound great in theory, but they must be designed keeping the needs of private citizens, businesses, and commercial banks in mind. It’s also crucial to consider the resources needed to create a healthy CBDC ecosystem and create new management and decision-making practices.

The impact of digital currencies on global economies should be studied in-depth, especially if economic policy shifts to accommodate CBDCs. Commercial banks must also introduce and bear the expense of better KYC and AML protocols to prevent misuse.

CBDCs could bring groundbreaking benefits to the world’s financial systems, but ultimately it’s up to governments and central banks to decide whether it’ll be worth the effort to develop. Though blockchain was invented to remove governments and financial institutions from the money equation, CBDCs are turning out to be one of the most compelling uses of blockchain the world has ever seen.