As the world increasingly embraces digital technology, the legacy financial system is adapting to the shift from an analogue to a more modern, digital framework. Partly in response to the rise of stablecoins, most famously Facebook’s aborted ‘Diem/Libra project, Central Bank Digital Currencies have emerged as another development in this digital transition. They represent a digital form of a nation’s fiat currency, issued and regulated by its central bank.
CBDCs claim to offer a blend of traditional banking and modern digital technology. Central banks state these digital currencies are intended to modernize existing monetary systems, aiming to enhance transactional efficiency. The idea is that CBDCs can streamline transactions, improve global remittances, and offer a more controlled and regulated digital currency option.
Key Characteristics of CBDCs
Centralized Issuance: CBDCs would be issued and regulated by a country’s central bank, ensuring centralized control over the currencies’ supply, use cases and value.
Digital Form: Unlike traditional money, CBDCs would exist solely in a digital format, with no physical counterpart like paper notes or coins. Many governments experimenting with CBDCs claim they do not intend to phase out physical cash. However, in practice, the design of a CBDC seems to be geared towards replacing traditional currency.
However, in practical terms, a CBDC cannot replace cash because, unlike cash, the ownership of a CBDC doesn’t transfer seamlessly and without restrictions at the point of transaction. The central bank or payment interface provider would always have the option to decline or block a user’s transaction, which cannot happen when cash is passed from hand to hand.
Legal Tender: CBDCs would be recognized as official legal tender by the issuing government, meaning they would need to be accepted for all debts and financial transactions within that country.
Regulated: CBDCs would be regulated by the central bank of their respective countries, ensuring compliance with domestic and internationally applicable financial laws and regulations. This regulation is aimed at maintaining the stability and integrity of the financial system, although the security of these digital currencies, like all digital systems, can be subject to centralised challenges.
Interoperability with Traditional Banking: CBDCs are being designed to seamlessly integrate with existing financial and banking systems, allowing for easy transactions and exchanges with traditional money.
Programmable and Trackable: Due to their digital nature, CBDCs can be programmed for specific uses and are easier to track, monitor, and control.
Accessible: CBDCs aim to be universally accessible, offering an inclusive financial tool that can be used by all citizens, including those without access to traditional banking services. However, existing CBDC models frequently include KYC or ID requirements, automatically creating a barrier to entry for the most vulnerable in society and likely excluding these people from participation.
Efficient Transactions: Digital currencies may facilitate faster and more efficient transactions, both domestically and internationally, compared to traditional banking systems, though it is unlikely that they will come close to reaching the theoretical throughput of Bitcoin’s Lightning network at circa 1 million transactions per second.
CBDCs would function within the parameters of established, centralized financial systems. As a result, they conform to and do not fundamentally challenge the underpinnings of these traditional structures. CBDCs may fall short of addressing the underlying issues affecting these systems by merely replicating existing frameworks, potentially missing an opportunity for genuine reform and innovation.
CBDCs maintain the centralized control typical of traditional financial systems. They allow central banks to tightly grip the monetary policy and currency flow within the economy. Traditionally, managing the economy involved tightening or expanding the currency supply. However, with CBDCs, this control can extend to directly influencing specific sectors. For example, they could restrict payments in certain areas of the economy or provide direct additional funds to incentivize others, even to the point of imposing an automatic negative interest rate or ‘holding cost’ on CBDC users.
Security and Privacy Concerns
Security is a significant concern in digital transactions, and CBDCs are no exception. While centralization can lead to more coordinated security measures, it also creates a single point of failure, making CBDCs potentially vulnerable to cyberattacks. The centralized nature of CBDCs raises privacy concerns, as it could enable governments to monitor and track financial transactions more closely. Some trial CBDCs can only be spent within a specific geographic area, which raises important questions regarding how users are being tracked and the fungibility of the money.
The Global Perspective on CBDCs
Globally, the adoption of CBDCs has been mixed. Some countries are actively exploring and piloting CBDC projects, while others remain cautious. Citizens in countries where CBDCs have been trialled have almost uniformly rejected them. The diverse approaches to CBDCs reflect the varying economic environments, technological readiness, and policy objectives of different countries. While some view CBDCs as a means to modernize their financial systems, others see them as a potential threat to financial stability and privacy.
CBDCs represent a step in the evolution of money in the digital age – but perhaps not an inevitable one. Their proponents will need to convince citizens to use them, and it is by no means clear that citizens will comply. They offer a way for traditional financial systems to adapt to the digital era, providing a more efficient and controlled alternative to cash. However, in terms of financial autonomy and innovation, CBDCs fall short.
This marks a fundamental transformation in how money operates; as there has never before been a concept of censorable cash.The future of finance is likely to be shaped by the coexistence of various forms of digital currencies, each serving different needs and purposes. However, there is a chance that CBDCs will become just a minor, largely forgotten footnote in the history of money, akin to a dead-end in the path of monetary evolution. CBDCs confront key challenges in privacy, security, and centralization, casting doubt on their future impact on global finance.