Central banks have stepped up efforts to explore the creation of their own stable digital currencies as a result of the significant increase in stablecoin circulation in recent years.
We examine the details below.
Central bank digital currencies (CBDCs) are created by a central bank and are intended to be legal tender. They provide a risk-free alternative to private bank deposits because they are tied to existing banknotes. CBDCs are also based on blockchain to increase efficiency and reduce costs.
A stablecoin, on the other hand, is a type of cryptocurrency whose value is pegged to another asset, such as the US dollar or gold.
Development
The interoperability and programmability of the first version of CBDC was limited when it was first introduced more than ten years ago. The next generation, CBDC 2.0, is likely to operate at a national or supranational level and could facilitate the automation of monetary policy, reducing the risk of hyperinflation in developing countries and narrowing the gap between rich and poor in terms of purchasing power. With CBDC 2.0, it is hoped that nations could reduce criminal activity, tax evasion and drug trafficking by improving traceability. (Source: Boston Consulting Group)
Reasons for introducing CBDCs
National governments and central banks have entered the digital asset market, and several intend to launch their own national digital coins
and tokens, so they are no longer wary of CBDCs. For example, due to sophisticated national and international gross settlement systems, payments can currently take days to clear and may even be exclusive. As pricing is typically based on volume, small and medium-sized enterprises often pay much higher rates than larger organisations. It is also more difficult for people and institutions in emerging markets to access international payment networks because of the challenges of meeting traditional requirements.
Current efforts
Opinions on CBDCs range from insisting that the current system is fine to highlighting the possibility that stablecoins are a logical evolution of the mix of public and private money that we have relied on for ages. The International Monetary Fund even suggests that “we have moved beyond conceptual discussions of CBDCs and are now in the experimentation phase”. “Central banks are rolling up their sleeves and familiarising themselves with the bits and bytes of digital money.” According to Reuters, more than 100 central banks are conducting studies or CBDC pilots
to promote financial inclusion and grow the digital economy. Eleven countries have already launched CBDCs, while more than 100 others, representing more than 95 per cent of global GDP, are now exploring them, with some significant milestones expected this year. In the Bahamas,
the Sand Dollar – the local CBDC – has been in circulation for more than a year. In addition, the Swedish Riksbank has developed a proof of concept and is exploring the technology and policy implications of CBDCs. Finally, in China, the digital renminbi (e-CNY) continues to make progress, with more than one hundred million individual users and billions of yuan in transactions. The Central Bank of the United Arab Emirates (CBUAE) is also planning to launch a central bank digital currency that will be valid for both international and local transactions.
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Public perception
A survey found that customers in emerging markets and those in countries with a developed internet infrastructure have very different perceptions of CBDCs. 91% of respondents in Nigeria, where a trial project began in October 2021, and 60% of consumers in Indonesia said they were also likely to accept digital currencies. In the US and Germany, however, these percentages drop to just 24% and 14% respectively, suggesting that CBDCs may offer a leapfrog opportunity for payments in developing countries with less sophisticated payment systems. (Source: G+D and OMFIF)
The future
Governments seem eager to take on the complicated task of making significant changes to the way money works. Bank of America stated in its research published in February that CBDCs will be a logical evolution of the current banking system. Furthermore, according to experts quoted by Reuters, central banks are likely to introduce locally issued digital currencies (CBDCs) in the coming years, despite the well-known ‘crypto winter’. To be widely accepted, CBDCs must be universal. They must fulfil multiple functions while remaining fully functional in current and future infrastructures and business models. Individuals and organisations need functionality to use digital currencies in a variety of contexts, from offline peer-to-peer payments to automated machine-to-machine transactions. Greater collaboration between the private and public sectors will be required to provide seamless experiences and ensure interoperability. Commercial banks and fintechs will play a more consumer-facing and operational role, while central banks will need to ensure that the right infrastructure is in place to issue CBDCs. Their knowledge of user behaviour and the success factors for adoption will be essential to develop CBDs that meet the needs of many countries and bring CBDCs to life.
As each economy is unique, there is no universal argument in favour of CBDCs. For example, if geography prevents physical banking, a CBDC could be an important step towards financial inclusion. In other cases, a CBDC could provide a crucial fallback if other forms of payment fail. The delicate balance between finance and policy requires time, resources and continuous learning from experience, including cross-country experience. Moreover, successfully deploying CBDCs, creating e-wallets, adding functionality and pushing the boundaries of technology will require close cooperation with the private sector as well.
