The Central Bank Digital Currency Race
A cashless society in the new world
The evolution of currency
From barter, to coins, to paper money—and now, a central bank digital currency (CBDC). The first government to launch a digital currency appears to be the Bahamas, with a national rollout scheduled to begin on Oct. 20. What are the benefits, challenges, and impact of this evolution?
Interest in CBDCs was prompted by technological innovations in the financial arena. The onset of the global pandemic earlier this year has accelerated the push for digital currencies even more. In fact, some 80% of the world’s central banks are investigating a CBDC, with 10% of those banks planning to issue their version within three years.
Differing from cryptocurrencies such as Bitcoin or Ether, a CBDC is the digital form of a country’s fiat currency. Similar to paper money or coins, a digital fiat currency is backed by the full faith and credit of the issuing government, while more traditional cryptocurrencies are decentralized networks based on blockchain technology.
Why a central bank digital currency?
As a form of central bank money, a CBDC is a medium of exchange and a store of value, similar to a more traditional fiat currency. Each country’s digital currency would have varying levels of access and degrees of anonymity.
A CBDC has the ability to revolutionize payments, provide greater payment efficiency, and improve financial inclusion.
Government officials could also use these innovative currencies to obtain a better sense of business activity. Armed with real-time data on economic activity, central bankers and policy makers could possess more direct control of the money supply. Further, using a CBDC would give them the ability to engage in more effective policy by quickly transferring funds to individuals, businesses or specific industries.
“In a CBDC environment, virtually all transactions are zero-knowledge encrypted, enabling privacy and precision to where an impending domino effect from something such as tumbling airline industries could be categorized and calculated,”
Matthew Dibb, cofounder and COO of digital asset management platform Stack, speaking to Forbes.
The zero lower bound rate is an economic term to describe when the short-term nominal interest rate is at or near zero. In such an environment, it is impossible for central banks to lower rates any further to try and stimulate growth, in what is called a liquidity trap. Central banks then have few measures at their disposal. With a full CBDC system (without any cash), central banks will have an additional tool to transmit monetary policy, allowing them to impose negative interest rates, in an attempt to prevent hoarding of money and encourage savings or spending.
The global pandemic highlighted the limited accessibility to the banking system for the more vulnerable members of society. As an alternative form of currency, a CBDC would increase financial inclusion and provide enhanced access for those without banking accounts.
According to a 2017 survey, approximately 8.4 million U.S. households were unbanked, while an additional 24.2 million were classified as underbanked. Overall, approximately 1.7 billion adults do not have a bank account, according to the World Bank, with a lack of money cited as the cause of this.
With transactions increasingly digital, moving toward CBDCs seems like a natural progression. Additional benefits of a digital currency include increasing the speed of transfers and reduced transaction costs for consumers. A digital currency will also limit exposure to viruses and infections — another item highlighted by COVID-19.
Challenges of CBDCs
Cyber attacks are a significant threat in a digital world. A government-backed currency system would need to have the highest degree of cyber resiliency possible, as an attack could have enormous repercussions for the global financial markets.
Maturity transformation presents another challenge, by introducing instability to the banking system. Maturity transformation occurs when banks take short-term sources like deposits and use them for long-term financing, such as mortgages, is a major income source for commercial banks. The possibility of a bank run, where a large number of savers attempting to withdraw money simultaneously, could cause the bank to liquidate long-term assets.
The role of central banks also comes into question. The Bank for International Settlements stated:
“CBDC raises old questions about the role of central bank money, the scope of direct access to central bank liabilities, and the structure of financial intermediation.“
While a digital currency would discourage tax evasion and money laundering, it also introduces the possibility of increased governmental scrutiny. Depending on its structure, a digital currency could give governments greater control, with the ability to track every unit of digital currency issued.
State of digital assets by country
The Bahamas
Since last year, the Bahamas has been testing “Project Sand Dollar,” targeting Oct. 20 for a launch. A digital currency would make it easier for some of the tourist destination’s more remote islands to accept electronic payments, just in time for winter travelers. The nation is planning on ditching the 14-day quarantine rule for visitors beginning Nov. 1.
China
The world’s second-largest economy is in the advanced stages of launching a CBDC. China is already the leader in mobile payments, with a majority of transactions done via WeChat Pay or Alipay, paving a seamless transition to a cashless society.
According to the South China Morning Post, the People’s Bank of China (PBOC) has already tested a DCEP (digital currency electronic payment) in over three million transactions. The PBOC aims to have the DCEP available in time for the 2022 Winter Olympics in Beijing.
At the recent Sibos banking and financial conference, PBOC Deputy Governor Fan Yiefie stated:
“PBOC regards digital renminbi as an important financial infrastructure for the future.”
The country is even working to have the digital renminbi used in toy vending machines, indoctrinating a CBDC to the youngest consumers.
European Union
The EU recently advised citizens to be “ready” for a digital euro, citing the current state of retail payments. The report states that a digital euro would exist alongside the current paper currency, create synergies, and contribute to a more resilient payment system. It would continue the continent’s integration, adding that issuing such a currency “would have pervasive effects on society as a whole.”
United States
Prior to the global pandemic, the U.S. was investigating the concept of a digital dollar. Obstacles presented in distributing federal stimulus due to COVID-19 brought the matter to the forefront for central bankers.
The Federal Reserve announced in August 2020 that it was assessing the role of a digital dollar with researchers from the Massachusetts Institute of Technology, in order to develop an experimental digital currency and better understand the technology behind such a system.
At the recent Sibos conference, a global financial services networking event, Kansas City Fed President Esther George said that while the central bank is investigating CBDCs, there were no imminent plans to launch one in the United States.
On the heels of the November U.S. elections, candidates have been mainly silent about a digital currency. President Donald Trump is known to be anti-crypto, while challenger Vice President Joe Biden has not been vocal about a CBDC one way or the other.
But, in a recent poll, almost 25% of Americans surveyed believe that the U.S. government should replace paper money with digital dollars. While this number is statistically low, it is up almost double from a year earlier.
Several other nations are also in advanced stages of launching a digital currency. South Korea announced that it would run trials on its digital currency through next year; Brazil has said it would be ready to launch its version by 2022, and the Bank of Japan has also started testing a digital yen. Meanwhile, Australia has been more skeptical regarding a digital currency.
Impact of a digital currency
A paper co-authored by several prominent employees of central banks emphasized the urgency surrounding CBDCs, stating that:
The aforementioned statement was highlighted in “Central Bank Digital Currencies,” which lists among its authors individuals working for the Bank of Canada, the European Central Bank, the Bank of Japan, Sveriges Riksbank, Swiss National Bank, Bank of England, the Board of Governors of the Federal Reserve System, and the Bank for International Settlements. According to the group, the aim of a CBDC should be to support policy objectives, and to do no harm to monetary and financial stability.
While the Bahamas is ready to launch its digital currency, the implications of China’s digital yuan have a far greater reach. If a digital yuan is launched, how will it affect U.S./China relations, or the greenback’s status as the world’s reserve currency? The U.S. dollar is currently used in nearly 90% of global transactions. As countries adopt digital currencies, they would be able to bypass the dollar to engage in bilateral trade, with major implications for all.
Markets are in constant flux, and the only thing certain is continued uncertainty. This information is for educational purposes only and should not be construed as trading advice. Past performance is not an indication of future results. Do not invest more than you can afford to lose. The author of this article may hold assets mentioned in this piece. To learn more about commissioning content with Analysis on Demand from Quantum Economics, visit quantumeconomics.io.
