As the world moves towards digital financial transactions, the emergence of cryptocurrencies and blockchain technology have made waves in the financial services sector. Central banks are now starting to take note and exploring the idea of issuing digital currencies. Central bank digital currencies (CBDCs) are the digital form of government-issued currency that is not pegged to a physical commodity. In this article, we’ll delve into what CBDCs are, their different types, where they are being used, and their potential benefits.
What is Central Bank Digital Currency (CBDC)?
CBDCs are digital forms of government-issued currencies that are not backed by any physical commodity. They are issued by central banks, whose role is to support financial services for a nation’s government and its commercial banking system, set monetary policy, and issue currency. CBDCs are similar to stablecoins, which are private, stabilized cryptocurrencies pegged to another currency, commodity, or financial instrument with the goal of maintaining a relatively stable value over time. However, unlike stablecoins, which are decentralized, CBDCs are state-issued and operated.
Different Types of CBDCs and Their Current Use
A wide variety of CBDC approaches are being piloted in various countries. One type of CBDC is an account-based model, such as DCash, which is being implemented in the Eastern Caribbean. With DCash, consumers hold deposit accounts directly with the central bank. Another model is China’s e-CNY, a CBDC pilot that relies on private-sector banks to distribute and maintain digital-currency accounts for their customers. At present, 87 countries, representing more than 90 percent of global GDP, are exploring CBDCs. Jamaica’s JAM-DEX launched in June 2022 and is the first CBDC to be ratified formally as legal tender. Nigeria, the first African country to roll out a CBDC, launched eNaira in October 2021. Sub-Saharan Africa is poised to adopt CBDCs. Project Aber is an initiative launched jointly by the central banks of Saudi Arabia and the United Arab Emirates that tested the use of a jointly issued digital currency as an instrument for domestic and cross-border settlements between the two countries.
Why Have Central Banks Become Interested in CBDCs?
Four trends have likely spurred central banks’ interest in CBDCs:
- Plummeting cash usage: Cash usage has declined significantly in recent years, forcing central banks to reexamine their role in the monetary system.
- Growing interest in privately issued digital assets: The use of digital assets like cryptocurrency can be viewed as a potential challenge to fiat currency as a unit of measurement for value.
- Decreasing sense of central banks as payments innovators: CBDCs offer central banks a new opportunity to lead strategic conversations on cash use cases in a public forum.
- Rising global payment systems: Central banks see CBDC as a potential stabilizing anchor of local digital payment systems.
Potential Benefits of CBDCs
Advocates of digital finance believe that CBDCs can address many issues related to efficiency, security, and access. Some potential benefits of CBDCs are:
- Reduced costs: CBDCs could save financial service providers $400 billion annually in direct costs by shifting spending away from physical infrastructure and toward digital finance.
- Increased speed: CBDCs could improve the speed and efficiency of many countries’ electronic payment systems.
- Greater access for those without bank accounts: CBDCs accessible through mobile devices could potentially increase financial inclusion.
- Heightened security: CBDCs could enhance payment security by ensuring that a transaction is finalized and unalterable.
However, CBDCs are not without risk, and their adoption isn’t a guarantee. Many underbanked people may favor the anonymity afforded by cash. Additionally, CBDCs require significant investments in new technology, and their deployment could potentially create new security concerns.
Final Thoughts
CBDCs are an emerging trend in the financial services sector. Central banks worldwide are exploring the possibility of issuing digital currencies to address the challenges posed by the growing use of digital financial transactions. While CBDCs have the potential to improve efficiency, security, and access to financial services, they are not without risks. The future of CBDCs remains uncertain, but it is clear that they could have a significant impact on the global financial landscape.
FAQs
- What is the difference between CBDCs and cryptocurrencies?
CBDCs are digital forms of government-issued currencies that are not backed by any physical commodity and are state-issued and operated. Cryptocurrencies are decentralized digital currencies that are not issued by any government. - Can CBDCs improve financial inclusion?
CBDCs accessible through mobile devices could potentially increase financial inclusion, but their adoption isn’t a guarantee. - Are there different types of CBDCs?
Yes, there are different types of CBDCs, including account-based models, privately issued models, and fiat currency models. - What are the potential benefits of CBDCs?
Potential benefits of CBDCs include reduced costs, increased speed, greater access for those without bank accounts, and heightened security. - Are CBDCs without risks?
No, CBDCs are not without risks, including the potential for new security concerns and the preference of some users for the anonymity afforded by cash.