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CBDCs: Changing the payment landscape

Central Bank Digital Currencies (CBDCs)

Launched in the year 2008, bitcoin (BTC) the blockchain-based money has accelerated the development of hundreds of digital currencies in a few years. The market is now more mature and diverse with the advent of open banking, lowering the entry barriers for startups. Big banks like J.P. Morgan and Wells Fargo have invested in these digital currencies to leverage the market potential. Now, these currencies are moving into the mainstream as various governments are exploring the technology.

Central bank digital currencies (CBDCs) are now into active pilot programs by several central banks across the globe. The central banks of China and Sweden are leading the way with developing digital versions of their currencies. Furthermore, many other nations are aiming to deliver a digital cash alternative for faster payments. We have talked about it in detail below.

What are CBDCs?

Many central banks across the globe are working on launching their own digital currencies. These currencies will be regulated, unlike cryptocurrencies, and backed by monetary reserves like gold. These regulated currencies are called as central bank digital currencies (CBDCs).

CBDCs represent the digital form of traditional fiat currency of a nation. They are issued and regulated by central banks and not by any state bank or a private company. Such a currency will act as a digital equivalent to a paper bill and can be used for making payments or as a store of value.

CBDCs can bring the best of both worlds — the security and convenience of digital money and the regulated, reserved-backed traditional money.

The main benefits of CBDCs

A couple of months ago, International Monetary Fund (IMF) published a speech where Tao Zhang, Deputy Managing Director, IMF talked about CBDCs. The speech examined the pros and cons of CBDCs and its impact on the current financial system.

In terms of benefits or advantages of CBDCs –

1. CBDCs can enable more efficient and affordable payment system in many countries where managing cash is expensive and proper access to the payment system is not available.

2. CBDCs can improve financial inclusion by providing secure means of payments without need a bank account.

3. CBDCs can bring more stability and lower barriers to entry for newer organizations in the payments sector. Some central banks view CBDCs as a way to enhance flexibility and increase competition in the payment system.

4. By promoting financial inclusion, CBDCs can also lead to improved monetary policy.

5. CBDCs can help governments to compete with fast-growing privately-owned digital currencies which may be challenging to regulate and pose a risk to financial stability.

Apart from the benefits highlighted by the IMF, CBDCs could modernize the entire payment system which will be fast, secure, and digitally-enabled. Where the payments could be linked by identities making it easily traceable and transparent for the governments and other authorities.

How governments are using CBDCs

A recent survey conducted by the Bank of International Settlements (BIS) shows that 80% of central banks are exploring CBDCs at some level. Currently, several central banks have initiated pilot programs to develop their own CBDCs.

Recently, Banque de France has initiated an experimental approach to CBDCs to improve the functioning of the financial market and interbank payments. They have also successfully tested a blockchain to issue and transfer the currency.

A few months back, the U.S. Congress published a draft bill for COVID-19 stimulus, which introduced the concept of the digital dollar, a CBDC. The digital dollar was introduced to enable the distribution of stimulus funds to lower-income citizens during the crisis.

Moreover, the Bank of England, the European Central Bank, the Bank of Japan and many others are currently exploring the technology. The BIS is also discussing CBDCs at length to promote contactless payments as they fear that contaminated currency bills may aid the spread of the virus.

The future of CBDCs

Looking forward, central banks have a substantial opportunity to boost financial inclusion into the system. Adoption of CBDCs at a global scale could be a key for central banks to offer a modern, cashless payment solution. We can imagine a completely new and advanced system of payments with the advent of CBDCs. This new system will be powered by technology and innovation and rely on central banks’ robust governance for these new assets.

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Yogesh Rawal

Yogesh Rawal

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Working as a content writer for more than 4 years. Based in Rajasthan (India).