What is a Central Bank Digital Currency?
A Central Bank Digital Currency (CBDC) is a digital form of a country’s fiat currency issued and regulated by the central bank. Unlike cryptocurrencies such as bitcoin, CBDCs are not decentralised, and their value is pegged to the country’s fiat currency. CBDCs are intended to promote financial inclusion, simplify the implementation of monetary and fiscal policies, reduce transaction costs, and improve the security and accessibility of digital transactions.
There are two main types of CBDCs: wholesale and retail. Financial institutions use wholesale CBDCs for interbank transfers, while retail CBDCs are for consumers and businesses and are categorised as token-based (offering anonymity) and account-based (requiring a digital ID).
What are the Benefits of CBDCs?
One of the primary goals of CBDCs is to promote financial inclusion by providing access to financial services to the unbanked and underbanked. CBDCs can be accessed through mobile devices, potentially extending financial inclusion to previously underserved populations.
CBDCs have the potential to significantly reduce transaction costs, particularly for cross-border transactions. By eliminating intermediaries and streamlining the payment process, CBDCs can make transactions faster and less expensive.
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CBDCs offer enhanced security compared to traditional digital payment methods. Transactions conducted with CBDCs are final and immutable, reducing the risk of fraud. In addition, the regulated use of private key cryptography can provide users with peace of mind and ensure the security of their transactions.
CBDCs provide central banks with a new tool to effectively implement monetary policy. By issuing and regulating a digital currency, central banks can influence credit, interest rates, and inflation to maintain economic stability.
What are the Concerns around CBDCs?
The introduction of CBDCs raises concerns about privacy and surveillance. Because CBDC transactions can be tracked, there is a potential risk of privacy violations. Striking a balance between transaction transparency and privacy is critical to the successful implementation of CBDCs.
CBDCs rely on technology to function, and any technological problems could disrupt the entire system. It is essential to ensure the stability and security of the technological infrastructure supporting CBDCs to maintain user confidence and trust.
Developing the infrastructure for CBDCs requires significant investments in technology and resources. Central banks need to carefully assess the business case for CBDCs and ensure that the potential benefits outweigh the costs.
The introduction of CBDCs could potentially affect the structure and stability of existing financial systems. Central banks need to carefully assess the potential impact on areas such as liquidity, capital requirements, and the role of commercial banks in the financial ecosystem.
Countries exploring CBDCs
China has been at the forefront of CBDC development with its digital currency electronic payment (DCEP) system. The People’s Bank of China (PBOC) has been piloting the e-CNY, a digital yuan, since 2019. The e-CNY is backed by the central bank and relies on private banks for distribution and maintenance.
The Bahamas are the first country that launched retail CBDC, called the Sand Dollar, in October 2020. The Sand Dollar aims to bring financial inclusion to the population, especially those in remote areas with limited access to traditional banking services.
Several countries in the Eastern Caribbean, including Antigua and Barbuda, Grenada, and Saint Lucia, have launched a retail CBDC called “DCash”. DCash allows consumers to hold deposit accounts directly with the central bank, promoting financial inclusion and reducing reliance on cash.
Nigeria has launched a retail CBDC called “eNaira” in October 2021, making it the first country in Africa to do so. The eNaira aims to increase financial inclusion and improve the efficiency of digital transactions in the country.
