Digital Currencies have been in the market for quite a while now. Despite being unregulated and not backed by a government, the multi-billion dollar business has proven its place in the global economy. Cryptocurrency’s history of illegal transactions and ICO fraud has scarred the industry’s reputation but have also shown a promising arena for investments and payments.
What was once an illegal and unauthorized practice, has become an inspiration for central banks. As digital currency payment systems gain firm roots in global economies, pressure builds for central banks to develop internal initiatives. Coupled with their zeal to move towards digitalization and establishing cash-lite societies; central banks are now in the process of evaluating digital currencies. Since these will be issued and backed by the government, they are called Central Bank Digital Currencies (CDBCs).
Issuing currency is a highly specialized area with profound implications on monetary policy. Central banks have been working together to establish rules, standards, and mechanisms to develop a shared thought process and overall understanding on this subject. As of today, no country has officially announced or issued a CDBC. It’s still a research/study area where certain experiments in controlled environments (regulatory sandboxes) are being undertaken. The Bank of International Settlement – BIS (also called the Bank of the Central Banks), in its report on CDBC – foundational principles and core features, reveals that nearly 80% of the respondent central banks (of the survey conducted on CDBCs) are studying CDBCs in one form or the other.
So what is a CDBC?
The BIS defines CDBC as a digital payment instrument, denominated in the national unit of account, that is a direct liability of the central bank. In simpler words, it is a fiat currency issued by the central bank in digital format.
Facilitate ease of payments due to inherent architecture that eliminates intermediaries
Establish a financially inclusive society - as access to finance for unbanked geographies will be enhanced
Bring transparency into the economy as every digital asset will have a unique identifier and issued on someone’s identifier
Discourage accumulation of funds acquired through corruption, money laundering and tax evasion because Central Bank and government entities shall be keeping an eye on all aspects of the transactions and respective accounts
Prevent criminal activity such as terrorist financing, drug supply-chains, tax evasion or avoidance, and other activities by tracking and observing the flow of money
Eliminate the costs and overhead involved in printing and handling physical money
Optimize monetary policy to assist central banks in making informed decisions about interest rates and discount windows
Eliminate fake currency - the counterfeit / fake currency is a threat to the economic system which is drastically reduced when the monetary system depends upon CDBC
Lead towards a documented economy where all stakeholders operate with a responsible conduct
The risks, fear, and concerns
Having mentioned the above benefits, the CDBC is not free from risks and concerns.
a) Trust shall be the biggest issue: It is common to keep family members out of the financial aspects of our business activities, investments, and savings. Despite being issued by a “trusted” Central Bank, it is uncomfortable to know someone is constantly monitoring every financial transaction; no matter how genuine and transparent our financial conduct may be.
b) Heavy dependence on IT infrastructure: CDBC is totally dependent upon the digital / IT infrastructure. A mere hacking attempt, virus, ransomware or alike may pose a serious threat to the whole CDBC financial system.
c) The fear of losing money: Since CDBC will be issued by a central authority, there will exist a fear that the authority may remove the money from anyone’s account by a single click. The need for consumer protection laws would emerge in order to gain public trust for mass adoption.
d) Implications in Cross Border fund transfer: Countries are skeptical about cross border funds transfer due to its profound implications. Considering numerous regulations enforced by each country in this arena, CDBC might require either a drastic change in the existing processes or warrant a totally new regime of rules and procedures for cross border payments and international trade.
e) Fuel bank runs: a bank-run is defined as the panic situation when people run on the banks to cash–out money from their bank accounts. This can turn into disastrous situations for individual banks and potentially cause a whirlpool effect for the devastation of the entire banking system. Likewise, CDBCs are not free from this characteristic. The central banks are carefully deliberating on this issue so as to minimize (or even eliminate) this risk.
The advent and rise of unregulated and non-fiat digital currencies have compelled governments and central banks around the world to realize the need for intervention. Central banks are working together to define, understand and execute the establishment of regulated, fiat digital currencies. The risks and rewards of CDBC need to be carefully addressed, the laws and regulations duly amended or renewed altogether, and a universal consensus built for cross border payments before we see a CDBC on ground due to its profound dynamics on the country’s financial system.