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Central bank digital currencies are a digital representation of a country’s fiat currency. They are effectively a government-issued cryptocurrency designed to replace the traditional, physical form of fiat currencies.
The term CBDC is broad because its implementation involves several critical decisions on the part of an issuing central bank. The primary decision is whether a CBDC should be a general-purpose in that it’s available to be used by the general population. If not, then the issuing authority may decide to make it available for “wholesale” transactions, which means the CBDC is only used for settlements between banks. Finally, a CBDC could also only be used among central banks.
According to the BIS, the idea of CBDCs has been around for many years, predating Bitcoin by over two decades. However, the concept has gained prominence over recent years. This has been mainly due to advances in the fintech arena, including developments in blockchain technology, allowing the issuance of digital tokens that represent a store of value.
Furthermore, the move toward CBDCs supports the general trend of a more cashless society. In countries such as South Korea, China and Sweden, cash is well on its way to becoming a redundant means of payment.
CBDCs offer many comparable benefits to cryptocurrencies, such as Bitcoin. Hours of operation for banks limit the availability of transactions, whereas CBDCs could be available to transact on a 24/7 basis. Banks could decrease their reliance on clearinghouses, which would save costs.
Like cryptocurrencies, CBDCs could be available to anyone who has a smartphone, helping to improve financial inclusion, particularly to people in rural areas without access to physical banking infrastructure such as ATMs. Countries such as Kenya have already seen an improvement in financial inclusion due to the popularity of M-Pesa, a cashless payment app based on SMS.
There are other benefits in using CBDCs beyond the general advantages of digital currencies. Central banks spend money to print money, with the average cost of minting a one-dollar bill racking up around $0.077 per note. Digital currencies are cheap or sometimes even free to produce once the underlying code is there.
Central banks could also implement monetary policy directly using a CBDC. This may mean paying interest on the token itself rather than on bank deposits.
Finally, governments could find it easier to distribute cash to citizens, using CBDCs. For example, COVID-19 led to a crisis that prompted the United States government to issue Economic Impact Payments in the form of checks and debit cards, which are prone to theft and fraudulent use. With a CBDC, the government could issue relief funds directly.
Finally, while governments could use a CBDC to implement monetary policy, the new possibilities that this opens could also create some degree of risk. For example, using a CBDC to charge negative interest rates in a time of crisis could fundamentally change economic paradigms, making it too costly for citizens to store their wealth in the new digital cash.
Banks now only need to implement the necessary software, hardware and security policies to be ready to start processing cryptocurrencies, which could also include a CBDC.
The COVID-19 relief effort is acting as a catalyst for the introduction of “digital dollars” as referenced in the Automatic Boost to Communities Act introduced by the U.S. Congress. This came after the introduction of a bill in March dubbed the Cryptocurrency Act 2020, which attempts to clarify the responsibility for regulating digital assets by federal agencies.
Although many central banks use some form of digital money as reserves or settlement account balance, no central bank has yet issued any general CBDC. However, several banks are already in various stages of research and development, including the five major currencies of the world, the U.S. dollar, the euro, the Japanese yen, the British pound and the Chinese yuan.
The most recent news from Japan is that the central bank has appointed its leading economist to head up a team researching a yen-based CBDC, while the Bank of England has appointed Accenture for its own CBDC development. Meanwhile, the European Central Bank appears to be leaning toward a retail CBDC, and given the fact it would operate across 19 countries, this makes it the biggest project at the moment.
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