The Lure of cryptocurrency is that there is anonymity and freedom from government intervention. But governments flag these absolute freedom highly risky. With central bank digital currencies (CBDC), the government aims to reach the convenience of digital to customers in a more secured environment. But do governmental regulations tend to rob the digital currency of its fundamental traits i.e. freedom and flexibility? Read More…
Background
The idea of central bank digital currencies (CBDC) came from cryptocurrencies and block chain technology. CBDCs are backed by a government and recognized as legal tender wherever they were implemented.
Origin
CBDCs are digital tokens, similar to cryptocurrency, issued by a central bank of that country. They are set to the value of fiat currency of that country. (Fiat currency is the legal tender currency issued by a country’s government traditionally in the form of bank notes and coins used for exchange goods and services). Technology has helped the governments and financial institutions to move from physical fiat money to a credit-based fiat model wherein balances and transactions are recorded digitally. The COVID-19 pandemic has accelerated digital payment methods world over. Some developed countries have experienced a significant decrease in the use of physical currency.
All over the world, governments are exploring the possibilities of using digital currencies backed by the government. Many governments are exploring how CBDCs will affect their economies, existing financial networks and its stability. The aim of CBDCs is to provide businesses and consumers with privacy, transferability, convenience, accessibility and financial security. CBDCs decrease the maintenance a complex financial system requires, reduce cross-border transaction costs and provide alternative money transfer methods with lower-cost options.
A CBDC becomes a part of money supply and facilitates the country’s central bank in the implementation of monetary policies to control the growth, provide stability, and influence the inflation. CBDCs are in digital form and more people using digital currency bring more people to banking network help the banking sector to promote financial inclusion and simplify the implementation of monetary and fiscal policy.
CBDCs, backed by a country’s government and controlled by its central bank, would provide a stable means of exchange to the households, businesses and consumers.
Response of the Governments world over
Many central banks have pilot programs and research projects to study the viability and usability of a CBDC in their economy. As of February 2022 countries Bahamas, Antigua and Barbuda, St. Kitts and Nevis, Monserrat, Dominica, Saint Lucia, St Vincent and the Grenadines, Grenada and Nigeria, have launched CBDCs. There are about 78 other countries with CBDC initiatives and projects. Some of them are:
- With respect to India, in the budget 2022 finance minister announced that the Reserve Bank of India (RBI) will launch its own digital rupee in the new financial year.
- Jamaica in its pilot program minted its first batch of CBDC in August 2021. Pilot program ended successfully in December 2021.
- Sweden’s Riksbank began developing an electronic version of the krona (called e-krona) after the country experienced decline in cash usage.
- The USA is investigating CBDCs to improve the domestic payhttps://www.investopedia.com/terms/c/central-bank-digital-currency-cbdc.aspments system, increase efficiency and reduce costs.
- The Bank of Englhttps://www.investopedia.com/terms/c/central-bank-digital-currency-cbdc.aspand investigating integrating CBDC into its financial system.
- The Bank of Cahttps://www.investopedia.com/terms/c/central-bank-digital-currency-cbdc.aspnada continues to research in implementing CDBC.
- Australia, South Africa, Indonesia, Brazil, Peru, Chile, Uruguay, Thailahttps://www.investopedia.com/terms/c/central-bank-digital-currency-cbdc.aspnd, Venezuela, Singapore and many others are exploring the possibility of introducing digital currency.
Types of CBDCs
Wholesale and retail are the 2 types of CBDCs. CBDCs that are wholesale are for financial institutions and retail CBDCs are for businesses and consumers.
Wholesale CBDCs are like holding reserves in a central bank that grants an account to deposit funds, for an institution, or use the account to settle interbank transfers. It facilitates the central banks to apply monetary policy tools, like interest on reserve balances or reserve requirements, to influence lending and fix interest rates.
Retail CBDCs are similar to a government-backed digital currency generally reserved for institutions. In this case, the government extends it to consumers and businesses. Retail CBDCs eliminate intermediary risk—the risk that banking institutions might become bankrupt and lose customers’ assets.
There are two variants of retail CBDCs possible, depending on the type of access they provide.
- Cash-based access involves CBDCs passed onto the recipient through a pseudonymous digital wallet.
- Account-based access is similar to the access provided by a bank account
The two types of CBDCs are not mutually exclusive. There is a possibility to develop a combination of both.
What is required for successful launch of CBDC?
As per the Federal Reserve, a CBDC may encounter some critical issues and they are to be addressed before one can successfully design and implement CBDC. :
CBDCs eliminate the third-party risk of events like bank failures or bank runs leaving residual risk with the central bank, high cross-border transaction costs can be lowered by reducing the complex distribution systems and increasing cooperation between governments in cross-border payments, as the dollar is still the most used currency in the world A U.S. CBDC would add support and preserve its position, financial inclusion and expansion in the access to the general public.
What are the issues to be addressed in CBDCs: Issues that need to be addressed before one can successfully design and implement CBDC are: financial structure changes, financial system stability, monetary policy influence, privacy and protection and cybersecurity
For example the financial structure of the U.S.A could drastically change, how it would affect household expenses, investments, banking reserves, interest rates, the financial services sector, or the economy is unknown.
The effects on the financial system’s stability of a switch to CBDC are unknown. For example, during a financial crisis, there may not be enough liquidity at the central bank to facilitate withdraws.
Central banks normally implement monetary policy to influence the interest rates, inflation, lending and spending. This, in turn, affects the employment rates. Central banks need to ensure that they have the required tools which are needed to influence the economy positively.
Privacy is one of the most significant drivers in cryptocurrency. However CBDCs would require intrusion by authorities to monitor for financial crimes to combat money laundering and financing of terrorism etc.
Learners’ Opportunity
Central bank digital currency (CBDC) is expected to give a big boost to the digital economy by providing efficient and cheaper currency management system. For more details check our program @https://online.ifheindia.org/
Discussion Question
Do you think CBDC remedies the “unfairness” of the crypto currency? Why?
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Source Article Shobit Seth- Central Bank Digital Currency (CBDC) – Investopedia-March 9, 2022