CBDCs: The Future of Money?

What are CBDC’s, and can they serve as a alternative to more risky digital coins for the time being?

Picture yourself on a nice beach, toes in the white sand, the sound of waves crashing in the distance, the ocean spray smell hitting your nose, and the sun’s rays radiating off your skin. Sitting with a nice drink in your hand, you are enjoying yourself in the Bahamas. Now you might be wondering, what in god’s name do the Bahamas have to do with blockchain??

Don’t let the beachy paradise distract you, the Bahamas have recently made a huge leap into the future of money as we know it. In October 2020, the Central Bank of the Bahamas introduced the world’s first central bank digital currency, the Bahamian Sand Dollar. This post will be an introduction and dive into central bank digital currencies, or CBDCs for short, an interesting and potentially futuristic phenomenon being researched, developed, and implemented by countries all over the world.

What are CBDCs exactly?

Simply put, CBDCs are a digital version of a government’s fiat currency. In a broad sense, a fiat currency is any type of money backed by a government decree or fiat. CBDCs work in the same manner as the U.S. dollar, European Euro, or Japanese Yen; the country’s central bank issues its CBDCs, with the backing of the federal government, and the general population uses the money as tender for buying goods or services or paying employees. Now you may be thinking:

“That sounds a lot like our regular money. I can just Venmo someone, and it’s all digital. What’s the difference?”

However, these types of transactions pass through your bank, your Venmo account, the account of the person you are sending the money to, and their bank. With CBDCs, a similar transaction would take place instantaneously on a single digital ledger. Further, since the currency is run directly through the central bank, consumers do not need a commercial bank account, such as Chase or Bank of America, to use a CBDC. This facet would provide those who do not currently hold bank accounts a way to transfer and exchange money on a digital platform. Admittedly, no countries currently operating with CBDCs utilize a blockchain network, but the technology can be used more heavily down the line. Thus, the remainder of this post examines current CBDC technologies, their pros, and cons, as well as how they could (and in my opinion should) be related to blockchain technology.

Additionally, there are different types of CBDCs: retail, wholesale, and hybrids of the two. Retail CBDCs are the more common version, the type implemented in the Bahamian Sand Dollar and currently being pursued by the U.S. Issued to the general consumer, retail CBDCs can be owned in a wallet or account and consumers can use them for general payments. Some benefits to this version include access to those who cannot access traditional banking and have no risk of bank failure because the funds are backed by the federal government.

Conversely, countries such as Singapore and Saudi Arabia, are concentrating their efforts on wholesale central bank digital currencies. This type of CBDC would be used by banks and other financial institutions to transfer funds and make payments. The main benefits of using a wholesale CBDC versus our current system are increased efficiency in transactions and improved security.

What are CBDCs NOT?

Now with all the types of CBDCs discussed above you may see some similarities between these digital currencies and other types of money, but there are some distinct differences. As mentioned above CBDCs are not our current fiat currency; they are a different type of fiat currency that still comes directly from the central bank but exists entirely online. Another connection some readers might make is to stablecoins. Stablecoins are cryptocurrencies tied to fiat currencies in an attempt to be more suitable for wide use in transactions but are quite different as they are not issued by a central bank and CBDCs are not cryptocurrencies. One of the main features of a cryptocurrency is that they are decentralized and run on completely decentralized platforms. CBDCs on the other hand, are issued and controlled by the central authority, a country’s central bank.

Costs and Benefits

Just as with any new technology, there are certain costs and benefits to implementing a central bank digital currency. Outlined below are a few of the most commonly discussed advantages and disadvantages of CBDCs:

Costs:

• Centralization: as CBDCs are issued and controlled by the central bank, they could, in theory, restrict certain types of allowable purchases
• Privacy: central banks would need some user data and would also collect all transaction data; with such a large amount of data there is bound to be some potential privacy issues
• Adoption: the main reason money has value, is because people believe it does. CBDCs would need some time to become popular enough for widespread use
• Competition: if retail CBDCs are introduced, commercial banks might lose some business, which can have a ripple effect on the financial industry
• Policy: A U.S. CBDC could create issues for the Fed by changing the demands of reserves

Benefits:

• Efficiency: transactions could be much faster, cheaper, and more secure
• Direct Access: many countries have large unbanked populations, CBDCs would reduce barriers to financial inclusion
• Bank Collapse: commercial banks have the potential to collapse, and so long as a country’s central bank is stable, so too will their money be
• Easy to track: CBDCs would be recorded on a digital ledger, which would make monitoring transactions much more efficient
• Innovation: CBDCs could allow for smaller private sector players to create new services that current digital money cannot do
• International benefits: with international cooperation, cross-border payments could be improved from the slow and expensive process it is today

The Effect on the Economy

As mentioned above, the Federal Reserve of Boston outlined some very macro issues that central bank digital currencies could cause. A complete change to the structure of the financial market, and the stability of the financial system as a whole could potentially be an effect of CBDCs. As mentioned, with the central bank controlling more of household and business use of currency, the use of commercial banks would decrease. A decrease in business for banks would result in a reduction in total bank deposits; banks use these deposits as funding to extend loans. Decreases in bank funding results in increased costs to borrowers with less credit available. As you can see, the control of currency creates a long chain of causes and effects, ending with more problems with lending and borrowing.

In a similar vein, other low-risk assets like money markets and Treasury bills could lose business to CBDCs with a similar result to loans. The paper states that these effects could be counteracted by making CBDCs unable to collect interest or by placing a cap on the amount of CBDC available. A cap on CBDCs available would prevent the Fed from being able to carelessly print however much money they want.

Central bank digital currencies, by definition, are controlled by the central bank, a very stable source. During distressing times, CBDCs could be a very safe asset to hold, and as such, other forms of money could be quickly converted to CBDCs. This ease of conversion could increase the frequency and severity of runs on the financial market (if you aren’t sure what a bank run is, take a look at this clip from our favorite Christmas movie — It’s a Wonderful Life). Again, the authors of the white paper suggest that non-interest-bearing CBDCs and a quantity limit could mitigate these risks.

Relation to the Chain

Up to this point, central bank digital currencies don’t seem to relate to blockchain in any way, shape, or form. We know they are not cryptocurrencies like Bitcoin, so how are CBDCs and blockchain-related? CBDCs are issued by the central bank and as such, they must be able to keep a record of all the users and their transactions. Also, blockchain is simply a public, distributed ledger; the chains of data, in this case, transactions and user data, would be the blocks added and verified as we’ve described in previous posts here.

Now, blockchain technology requires a distributed network to function properly, and introducing CBDCs could cause major disruption in the banking industry. Thus, commercial banks could become a part of the blockchain network that CBDCs could run on, which could, in a minor sense, reduce the impact that CBDCs have on the financial sector. Put simply, the interaction between blockchain and central bank digital currencies is that blockchain serves as the ledger for the transactions of CBDCs. So essentially, in an idealist world for CBDCs the central bank makes the ledger publicly available and distributes the network, whether it be to commercial banks or other public players.

Back to the Bahamas

The Bahamian Sand Dollar was introduced in October 2020 by the Central Bank of the Bahamas as the world’s first nationwide central bank digital currency. The geography of the Bahamas is unique in the fact that the nation is split up into many different islands. Consequently, commercial banks do not operate in all areas because it is simply not profitable; due to this fact, nearly one-fifth of the country’s population does not hold a bank account. The introduction of the Sand Dollar is meant to help include more citizens who are not able to regularly access commercial banks. Further, officials believe security against money laundering and other illegal activities could be improved from the Sand Dollar.

Similarly, almost one hundred countries worldwide are pursuing central bank digital currencies in some form. Across the Atlantic from the Bahamas, Nigeria was Africa’s first country to launch a CBDC. So far, over 700,000 downloads of the eNaira wallet have occurred out of Nigeria’s 219 million citizens. The digital wallet can be accessed through a smartphone and can be used for in-store payments and money transfers. The technology does not come without issues. According to a Nigerian media outlet, while nearly 90 percent of Nigerians use mobile phones, only 10–20 percent have smartphones. Further, the government requires that users have a national identification number, which has led to much criticism.

Another digital currency has been introduced in not one, but seven different countries. The Eastern Caribbean Currency Union was the first world currency union to introduce CBDC and includes the countries of Antigua and Barbuda, Dominica, Grenada, Montserrat, St. Kitts and Nevis, Saint Lucia, and St. Vincent and the Grenadines. The eighth country in the union, Anguilla, chose to opt-out. Again, the main attraction of the so-called DCash is to help serve those people without bank accounts as well as speed up transactions. Anyone with a smartphone can download an app and transfer money or purchases via a QR code. Citizens without prior bank accounts would have to visit some sort of financial institution to have their identity verified before being approved for a DCash wallet.

While those nine countries are the only fully launched systems, more than a dozen other countries are currently testing out CBDCs in their pilot programs. In Sweden, the Riksbank has developed a proof of concept and is exploring the e-krona. Before complete implementation, Sweden wants to ensure that there is broad access, especially to elderly and disabled citizens, to make sure they aren’t negatively affected in a potentially cashless society.

The largest economy to pilot a central bank digital currency is China in April of 2020. The People’s Bank of China has successfully gotten more than a hundred million users of the e-CNY or digital yuan. The Beijing Winter Olympics provided digital payment services to visitors; simply download the e-CNY wallet app or store the currency on a physical card. Over in Eastern Europe, the National Bank of Ukraine has been exploring CBDCs since 2016 and is still researching and making progress on the system during their ongoing conflict with Russia.

Three of the largest economies in the world, India, the U.S., and the Eurozone are all developing CBDCs as well. The digital rupee, backed by the Reserve Bank of India, is expected to be up and running in March 2023. The European Central Bank has continued to work on developing its digital euro with a close eye on how other cryptocurrencies were affected as the COVID-19 pandemic accelerated a shift from cash. Finally, President Joe Biden ordered the U.S. Treasury Department and Commerce Department to prepare reports on the digital dollar and how it can help the five percent of Americans without access to bank accounts. However, all of these efforts are still being developed and could take years to be implemented fully.

And we can’t forget about the talk of the town recently with the conflict in Ukraine — Russia. Ever since 2014, the EU and powerful countries like the U.S. have imposed sanctions on Russia for their continued conflict with neighboring regions. The mere $300 billion in frozen assets presents many problems for Russia, if only this money weren’t able to be controlled by centralized entities and instead be more ~decentralized~. While they may not be using CBDCs yet, Russian vendors and other institutions can bypass sanctions in a roundabout manner. The majority of sanction enforcement comes through the financial system; banks must apply the “know your customer” rules and only allow payments to and from trusted and non-sanctioned sources. Russia is going one step further by trying to implement its CBDC, the digital ruble. Once this system is implemented, any country or business willing to engage with Russia could make payments outside the international banking community and completely evade the U.S. and other Western countries’ sanctions.

The Future of Money?

In his executive order to the Treasury and Commerce Departments, President Biden stated that he wanted the reports to focus on “the future of money.” With nine countries fully implementing systems, only time will tell the effectiveness of central bank digital currencies. However, there are many clear benefits to introducing a more secure, more efficient, and more accessible form of currency. Of course, some aspects of CBDCs still need to be improved upon, and the macroeconomic effects of the technology need to be further evaluated. In the meantime, head down to the sandy beaches of the Bahamas and buy a drink with a Sand Dollar, the potential future of money.

We hope you enjoyed this look at central bank digital currencies and their relation to the blockchain. Be sure to stay tuned for the next look in the series, a post on blockchain’s involvement in the gaming industry.

Blog Contributor:

Matt Brotnow | Mbrotnow | https://medium.com/@mbrotnow20

Resources Used:

1. Bahamian Sand Dollar — Whitepaper of the world’s first launched CBDC.

2. Motley Fool — A brief description of the CBDCs, the different types, and some pros and cons.

3. Boston Federal Reserve — A review and opinion on the Boston Federal Reserve whitepaper on CBDCs.

4. Euronews.net — A description of the global development of CBDCs

5. CBDC Tracker — Interactive map and statistics of global development of CBDCs

6. The New York Times — Article about current sanctions on Russia from the EU and U.S.

7. LawFare — Legal explanation of utilizing Russia’s assets and the future of Ukraine economically.