by Fatma Ceren Morbel
Central Bank digital currencies aren't just opportunities, they're also risks. The matter requires careful consideration. This post will provide a short overview of Central Bank Digital Currencies and highlight their most significant advantages and disadvantages.
Throughout history, various forms of exchange have been used, including seashells, rice, salt, gold, silver, and paper money. Even though Friedrich Hayek argued for the denationalization of money in 1976, it has only recently become a reality. In addition to inflation, digitalization appears to be the most significant challenge facing central banks. Therefore, in recent years, the introduction and development of cryptocurrency have enabled central banks to grow interest in issuing their own digital currencies in order to ensure their control over the money supply. In the present day, several countries have already created their own Central Bank Digital Currency (CBDC); others are working on developing them, but it is no accident that this happens at a time when cryptocurrencies are falling in value. Due to the popularity of CBDCs around the world, it is crucial to understand what they are, as well as their advantages and disadvantages.
The term "digital currency" refers to any currency that is available exclusively electronically. Cryptocurrencies, stablecoins, and central bank digital currencies constitute the three main types of digital currency.[1]
A CBDC is a virtual currency backed and issued by a central bank and it can be considered as a result of the rise of cryptocurrencies. A CBDC is a digital representation of a country's fiat currency. Instead of printing money, the central bank issues electronic coins or accounts that are backed by the full faith and credit of the government.[2] There are several factors that motivate the central banks to develop CBDCs such as digital revolution, monetary transmission, cryptoassets and financial inclusion. [3]
A CBDC can be used in wholesale (by financial institutions) or in retail (by households and businesses). Also, a CBDC can be an account-based system, requiring some form of identification, or a token-based system, allowing anonymous payments.[4] For retail use, we can highlight the projects that have been launched in the Bahamas, Nigeria, and Jamaica. Moreover, Sweden, Russia, Iran and South Korea are in the pilot step of retail use, while Singapore, Malaysia, Saudi Arabia and the United Arab Emirates are in the pilot step of wholesale use of CBDCs. Several countries are in the process of exploring both uses, such as Canada, the U.S., the UK, and Japan.[5]
The Bahamas launched the “Sand Dollar” (digital version of Bahamian dollar) in October 2020 as a first nationwide CBDC in the world. As a result of the geography of the Bahamas, which contains many different islands, a significant number of citizens do not have access to financial services and do not have bank accounts. It is considered that through the use of the Sand Dollar financial inclusion can be improved.[6] Nigeria is another country that launched a CBDC, the “E-Naira” which is stored in a digital wallet and is used for both contactless in-store payments and money transfers. The Eastern Caribbean, on the other hand, became the first currency union to start this practice with its digital currency.
The digital yuan (digital renminbi) is the first digital currency to be issued by a major economy, China’s central bank, the People's Bank of China. The motivations that led China to develop its own CBDC are summarized by Mu Changchun, the Director of the Digital Currency Research Institute, The People’s Bank of China, as follows:[7]
It aims to improve the efficiency of the central bank payment system and provide the backup or redundancy for the retail payment system, also, it helps to improve financial inclusion. Because mobile payments have become so prevalent in China, especially after COVID, foreign visitors may encounter difficulty in making payments since most merchants in China do not accept cash as a form of payment.
In Europe, the European Central Bank announced its intention to create a digital version of the Euro (digital Euro or e-Euro). It is planned that the investigation phase will assess the potential impact of a digital euro on the market, as well as identify the design options to ensure privacy and avoid risks to citizens, intermediaries and the overall economy of the euro area.[8] Sweden is one of the first countries that launched the pilot use of the CBDC. The Swedish Central Bank (The Riksbank) wanted to create a new payment system after the decrease of physical money and introduced the “e-krona” digital currency.
Depending on the country, central banks may develop CBDCs for different reasons. For instance, some countries where the majority of the population does not have a bank account are issuing CBDCs in an effort to improve financial inclusion, while others are developing them to enhance the capital market efficiency.[9] Another benefit is that through the use of CBDC, seniorage revenues can be increased, which is the difference between the face value of money and what it costs to produce it. Furthermore, as transaction costs are reduced and financial products become more widely available, the CBDCs are likely to increase gross capital flows as well.[10] Using CBDCs can result in faster payments, since Internet access enables transactions to be made at any time. Since it is difficult to follow the track of the revenues and expenditures in the physical money system, it allows for an unrecorded economy. The CBDC system, however, allows all payments to be logged and controlled by the central authority, therefore making it much easier to detect criminal activity, although it also means that other unrelated activities and personal information could be collected as well, which may discourage people from using the currency.
Apart from the advantages, CBDCs may bring some challenges as well. CBDCs are vulnerable to cyber attacks, thus, they need to be made resilient against them. Additionally, they can be subject to speculative attacks. Inadequate infrastructure and the unwillingness of the elderly to adapt to changing technologies can also pose challenges to the transition.[11]
As a result of the fact that the countries that have adopted cryptocurrencies do not place a high priority on privacy, there are also some concerns regarding this technology. Cryptocurrencies can be traced since they are programmed money. This technology also raises controversy regarding the "right to be forgotten" regulation under the GDPR, since blockchain technology is decentralized and therefore cannot be deleted. Regarding the concerns about privacy, one of the projects of the BIS Innovation Hub, namely “Project Tourbillon”, aims to explore cyber resiliency, scability and privacy in a prototype CBDC and also to resolve privacy concerns by providing privacy for the payment sender but not for the recipient.[12]
As a conclusion, since many countries plan to launch a CBDC system, it is important to take the necessary precautions, including protection against cyber attacks, and the cooperation of international organizations is crucial to the success of CBDC implementation.
[1] David Rodeck, Michael Adams, Digital Currency: The Future of Your Money, 2022.
https://www.forbes.com/advisor/investing/cryptocurrency/digital-currency/
[2] Atlantic Council, Central Bank Digital Currency Tracker, 2022.
https://www.atlanticcouncil.org/cbdctracker/
[3] Lámfalussy lectures conference: New dimensions of central banking in the post-covid era, 6 February 2023, Central Bank of Hungary, Budapest, Hungary.
[4] BIS Working Papers No 976, Central bank digital currencies: motives, economic implications and the research frontier, 2021, p. 3.
https://www.bis.org/publ/work976.pdf
[5] Atlantic Council, Central Bank Digital Currency Tracker, 2022.
https://www.atlanticcouncil.org/cbdctracker/
[6] Ian Smith, Central Bank Digital Currencies: Which countries are using, launching or piloting CBDCs?, 2022.
https://www.euronews.com/next/2022/03/09/cbdcs-these-are-the-countries-are-using-launching-or-piloting-their-own-digital-currencies
[7] Lámfalussy lectures conference: New dimensions of central banking in the post-covid era, 6 February 2023, Central Bank of Hungary, Budapest, Hungary.
[8] European Central Bank, Press Release, Eurosystem launches digital euro project, 2021.
https://www.ecb.europa.eu/press/pr/date/2021/html/ecb.pr210714~d99198ea23.en.html
[9] Marius Jurgilas, Senior Vice President, Super How, Lámfalussy lectures conference: New dimensions of central banking in the post-covid era, 6 February 2023, Central Bank of Hungary, Budapest, Hungary.
[10] Tobias Adrian, Tommaso Mancini-Griffoli, A New Era of Digital Money, 2021.
https://www.imf.org/external/pubs/ft/fandd/2021/06/online/digital-money-new-era-adrian-mancini-griffoli.htm
[11] Bank of England, Discussion Paper, New forms of digital money, 2021.
https://www.bankofengland.co.uk/paper/2021/new-forms-of-digital-money
[12] Project Tourbillon, BIS Innovation Hub.
https://www.bis.org/about/bisih/topics/cbdc/tourbillon.htm
