Crypto and distributed ledger technology (blockchain) continue to evolve at breakneck speeds. Governments also are fostering this discussion as they investigate implementing their own Central Bank Digital Currencies (CBDC). More than 80 countries around the world are researching or developing CBDCs, and are at various stages of the investigating process. On January 20, 2022, the U.S. Federal Reserve issued a discussion whitepaper highlighting the features/benefits/risks of such a payment system and acknowledged they are actively investigating it. Some governments have already postponed or canceled projects, while many are still investigating the pros and cons, and others have already launched their own digital currencies.
Understanding What a CBDC Is
Each CBDC is a digital representation of a country's existing fiat money, and it works much the same way. It is important to note that in the existing U.S. currency structure, most money is already virtual, as 96% of existing currency is held digitally and not in the form of bills and coins. CBDC moves the digital currency onto a distributed ledger platform (DLT) hosted by the central bank. This has major implications, including speed of transactions, security, transparency and fundamental changes to the existing banking structure.
Pros and Cons
How does it work? A country's central bank issues its CBDC, which has the backing of the federal government. That CBDC can then be used as legal tender for transactions such as paying employees or buying goods and services. There are a variety of implications of developing such a payment system. For example, transaction security is improved greatly, but as this is a sponsored system, the host (the central bank) has increased oversight capabilities. This type of payment system holds pros and cons for consumers and merchants, and implications to the banking industry.
CBDC could bring in the best of both worlds: convenience and security that comes with digital currency along with regulated and backed money in the current traditional banking system. With cash on the decline, CBDC could provide a digital alternative free of credit and liquidity risk.
Cons include the disintermediation of banks and increased cybersecurity and privacy concerns. Unlike cash, all digital purchases are tracked and an enormous amount of new consumer data would be available in the banking system. Also, if enacted in the U.S., the Federal Reserve could maintain retail accounts, resulting in an expanded role in the financial system and economy.
The Future is Here, Now
With over 80 countries acknowledging they are currently investigating or have investigated issuing CBDC, this is not simply a theoretical discussion. Nigeria has issued eNaira, the first African nation to issue a CBDC, while The Bahamas has launched the Sand Dollar, their CBDC. China has also acknowledged that it is testing a digital yuan, also known as the digital renminbi or digital RMB.
There is a distinction between retail CBDC programs, designed as a payment system for consumer use, and wholesale CBDCs, which would be used by financial institutions. Banks and other financial institutions could use a central bank's CBDC to transfer funds and settle transactions more quickly, and safely.
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