Central Bank Digital Currencies (CBDCs) have been a hot topic lately. After the big news that PayPal is starting to support cryptocurrency, the payment giant recently announced in its third-quarter earnings report that it is also interested in central bank digital currency. In its third-quarter earnings call, Mastercard said it was ready for a future in which central bank cryptocurrencies play a prominent role, stressing to investors that its existing patents could accommodate any development direction. But is all this just the guesswork of the giant payment company alone? The opposite is true. In a conversation with the International Monetary Fund (IMF) in mid-October, Fed Chairman Jerome Powell admitted that central bank digital currency could improve existing payment systems. The reaction of the crypto market is enthusiastic. In particular, Bitcoin surged 2.5% shortly after Powell’s announcement.
What is a CBDC and How Are They Different from Cryptocurrencies? What is a central bank digital currency and how is it different from cryptocurrency?
Although there have been long exchanges with cryptocurrencies, central bank digital currency and Bitcoin do not have much in common. Bitcoin is based on blockchain technology. It is a form of generating new bitcoins as a reward for the miners, inducing them to check transaction blocks over and over again. The Bitcoin miner network is decentralized and open, so anyone can provide the necessary equipment and mine Bitcoin. Also, Bitcoin is a non-fiat currency. Since the issuance of new bitcoins decreases over time, their value can be boosted through scarcity. (If you are curious about USDT, ETH, and other stablecoins? You can check them out at Talking Stablecoins.) Conversely, central bank digital currency literally refers to digital money issued by a central bank. It could be based on a blockchain or some sort of distributed ledger, but it doesn’t have to be. For example, while China is paving a new path with digital yuan, it is known that digital yuan is not based on blockchain. Moreover, although still in the research phase, central bank digital currencies are unlikely to be based on an open blockchain where anyone can join due to cybersecurity concerns. Central bank digital currency is expected to serve as either a complement to physical cash or to replace it with a digital equivalent. Therefore, even when central bank digital currency is issued, it is subject to central bank control in the same way as fiat money. Inevitably, its value is determined by the value of the national currency. Finally, central bank digital currencies may not be used as full cash equivalents as any consumer understands. Some studies on central bank digital currency have also deeply explored the possibility of being used entirely as a central bank payment method rather than being issued as a currency for the general public.
Countries leading the development of central bank digital currencies
In early October, the Bank of International Settlements (BIS), along with the central banks of seven working countries, published a recent report on central bank digital currencies. The report set out the three pillars of central bank digital money: coexist rather than replace cash, support broader policy objectives without damaging the economy, and promote innovation and efficiency. This isn’t buzzing news in and of itself, but it does show that digital currencies are one step closer to bearing fruit. BIS works with the banks of major economic powers, including the Federal Reserve, the European Central Bank, and the Central Banks of Canada, the United Kingdom, Japan, Sweden and Switzerland. Earlier this year, BIS issued a report confirming that a total of 80% of central banks are committed to research or development of central bank digital currencies. Among them, the development stage of China is probably the most advanced. In early October, the People’s Bank of China distributed approximately 10 million digital yuan (approximately US$1.5 million) to citizens of four cities as part of the central bank’s digital currency program. Since then, over 4 million transactions have been made. The US government is pretty far behind. Still, positive developments had already occurred before Jerome Powell approved the digital dollar in October. Last July, the Monetary Authority announced that all federally accredited banks wereBy issuing a letter allowing crypto custody services,it paved the way for the US to mainstream digital assets. Other than that, Japan, Thailand, Australia, and the Philippines are all building their own central bank digital currency, although at different stages of development.
What are the advantages of central bank digital currency?
Central bank digital currencies offer a number of distinct advantages to central governments. It is much more efficient than the current clearing and settlement system, and it can reduce the cost of physical coinage. Central bank digital currency eases the process of allocating payments to citizens. For example, during the COVID-19 pandemic, the U.S. government mailed welfare assistance checks to recipients of welfare assistance. The mailing process was slow, cumbersome and highly susceptible to fraud and theft issues. In this context, central bank digital currencies offer huge benefits for citizens as well. It can also lower interbank and cross-border remittance fees and promote financial inclusion. The average person may find it easier to create a central bank digital currency account than a traditional bank account that requires a government-issued ID.
What are the downsides?
There are two opposing concerns about the adoption of central bank digital currencies. Banks will want to ensure that digital currencies are resilient enough to withstand cyberattacks. It is terrifying to imagine that a hacker could take over 51% of the network with a 51% attack and double-spend for a digital version of fiat money. Similarly, governments will want to ensure that digital currencies do not pose a risk of being used for money laundering or other illegal activities. However, these security and crime prevention measures must be balanced with legal privacy concerns. If all of an individual’s financial transactions were tied to that blockchain account, the anonymity that digital currency could provide for an individual’s physical cash transactions would be severely compromised. Therefore, these privacy concerns can be a deterrent to the adoption of digital currencies.
The future of central bank digital money
Although frequently talked about, there is still a long way to go before a central bank digital currency is fully deployed. It takes a lot of effort and development phase. However, the increasing likelihood of central bank digital currency adoption, despite a number of risks and concerns, is also a boon for the broader cryptocurrency market. The introduction of digital assets by central banks means positive support for the technology, which means that the technology can exist in the market for a long time. Not only that, but the fact that central bank digital currencies can compromise some privacy will make BTC even more valuable. BTC will still remain a decentralized, anonymous coin. Overall, we expect central bank digital currencies and well-established cryptocurrencies to exist side-by-side, with each contributing, with parts playing a greater role than the sum.