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Lately, many people have been talking about CBDCs and their potential development. As the world shifts more toward cashless payments and cryptocurrencies, CBDCs are especially getting more attention from governments around the world. This guide will cover more about what they are, how they work, where they’re available, their future, and how they compare to stablecoins.
In the world of finance, the term ”fiat” refers to a currency that’s backed by a government, instead of assets such as gold. It’s typically been used in the form of tangible coins or banknotes. With the rise of technology and digital transactions, some governments have developed ways to supplement fiat currency with a digital credit model. Transactions using this model are digitally recorded.
Although countries still use and accept standard currencies, the use of cash is decreasing in many places. More people are using credit cards, debit cards or e-wallets for transactions. CBDCs and their development gained more attention during the widespread shutdowns associated with the COVID-19 pandemic that began in 2020.
As more people around the world are showing favor toward cashless payment systems and cryptocurrency use, governments are looking for ways to offer digital currencies as they realize their potential benefits. Currently, only a few countries have issued digital currencies.
Since countries today use fiat as their national currencies, a CBDC is often referred to as a digital fiat currency, each of which has its own unique identification that prevents counterfeiting.
Although CBDC payments are digital, they aren’t like electronic checks, which are essentially instructions for a bank to send money from an account holder to a recipient. To process standard digital payments, several parties must be involved in order to handle money, verify transfers, and complete other activities.
Alternately, CBDCs are conceptualized to be more like cryptocurrencies, eliminating these intermediary parties. CBDC payments can travel directly from one account holder to another.
An additional similarity between cryptocurrencies and CBDCs is their dependence on a network that validates and tracks them. Cryptocurrencies use blockchains, which adds the benefit of anonymity while ensuring transactions are recorded on a digital ledger.
While a CBDC could function on a blockchain, it’s usually connected instead to a central database that’s controlled by the issuing bank. The central bank is responsible for providing each piece of the currency, with a unique identification number for tracking. Central banks that utilize a digital currency may also attach it to the country's national currency.
CBDCs that are backed by fiat remain valid, regardless of payment systems that transfer or store it, and they may be transmitted through many types of digital payment systems. To make CBDCs more accessible to everyone in a country, proposals for these currencies often include requirements for all citizens to have an account with the issuing central bank.
Multiple factors drive any central bank digital currency. First, there’s a need for sovereignty. Sovereign money is one component of a healthy financial system and economic growth within a country. A central bank digital currency can bring back the central bank to the center of creating currency and building trust. Another driver of CBDCs is the need to make financial systems more efficient.
Two other common driving factors of a central bank digital currency are the need for better financial inclusion policies and the need to improve access to financial systems for people who lack it, sometimes referred to as unbanked people. In many countries, poorer populations rely heavily on cash, and that may be a barrier. However, central banks can develop open, two-tiered systems that convey more value to such individuals.
A final driver behind CBDCs is the need to improve fiscal and monetary policies. The digital tokens can minimize liquidity squeezes, and give a nation's citizens an easy-to-access alternative to other payment methods.
Some potential achievements that CBDCs can produce address the factors covered in the last part of the previous section. However, governments may have some broader goals as well. These are the main objectives that governments hope to achieve with a central bank digital currency:
Improve fiscal and monetary policies
Reduce reliance on payday loans, money orders and other expensive services
Solve financial inclusion challenges and provide better access to underserved populations
Make financial systems more efficient with real-time data benefits
Provide payment solutions that offer convenience, privacy, easy transferability and financial security
Lower the costs of cross-border transactions
Reduce maintenance demands that more complex financial systems require
Add stability through financial sovereignty and provide a way to back other digital payment systems in case of disruptions.
There are many conceptual ideas for CBDCs in countries which are considering, but haven’t yet released, digital currencies. The last point in the previous list is especially important to consider in conceptualization and implementation.
In order for a central bank digital currency to hold its power, it must be able to maintain popularity in its use. Governments must consider the possibility of lower rate transmission, and how that can hurt a digital currency.
When people in a country use currencies that aren’t part of its sovereign currency, there’s a risk that its use can dwindle. For example, many people today use cryptocurrencies, and there are more crypto stablecoins being developed all the time. If there’s a shift in a given country toward greater use of a few leading cryptocurrencies instead of its own CBDC, that subtracts from its power.
Since cryptocurrencies are backed by blockchains and offer anonymity to users, they can be highly attractive. Competitive benefits are issues governments must consider when planning or considering the use of CBDCs, as well as how to convey their value to the population.
There are still many potential benefits to a central bank digital currency. Governments must look for opportunities to mitigate threats and risks if they want to build a strong digital currency. Additionally, such challenges provide a way for governments to work with and strengthen domestic private payment systems to maximize efficiency, and to make them more fitting for the designed purposes. Doing this can also create ways to improve international payment systems.
To achieve their objectives, governments must plan CBDCs to solve problems, and must convey their differences and benefits. For example, a national digital currency is backed by the central bank, not by commercial banks. A government must find the advantages of such a structure, and convey how it solves problems for the people in that regard. However, a common obstacle for many governments may be the issue of trust in countries where there’s already widespread lack of faith in the national government.
There are two main forms of CBDCs, which fit different purposes. A national currency system doesn’t need to only use one. In the upcoming section, some examples of hybrid systems will be covered.
These types of government-backed currencies are for businesses and consumers to use. The purpose of a retail CBDC is to eliminate the risks of private currency issuers going bankrupt and customers losing money. With retail CBDCs, there are two types.
The first is structured as an account. For access, a form of digital identification is required. There’s also a token structure, which uses private or public keys. The main difference with a token-based structure is that it allows anonymity for users, since it requires a token instead of user identification.
Similar to a central bank's holding reserves, wholesale CBDCs allow central banks to offer accounts for users to transfer funds. The bank settles interbank transfers and uses its monetary policies to assign interest rates and effect lending activity.
The main difference between this structure and retail is that wholesale makes financial institutions the intermediaries between customers and the banks. With a retail structure, the relationship between central banks and citizens is more direct.
There are a few countries which have CBDCs, a couple of them with designs similar to stablecoins. There are also governments currently developing CBDC test projects.
The Atlantic Council published a survey in early 2022 and found that 87 countries — almost half the world’s nations — were considering issuing CBDCs. This finding is significant since research from 2020 showed that only 35 countries were considering developing their own digital national currencies at that time. The following sections cover important points about some countries that have either already launched a digital currency or have favorable plans for one.
Nigeria launched its digital currency in 2021, becoming the first country in Africa to do so. The currency is called eNaira and is available to users through a digital wallet. People in Nigeria can use the currency for contactless payments in stores, and can send money transfers with it.
The eNaira uses a hybrid system that includes wholesale and retail CBDC structures to allow greater flexibility and improved financial access to citizens. Nigeria's central bank issues the currency, and citizens hold it directly in their digital wallets. The currency is backed by the Hyperledger Fabric blockchain, which is a permissioned and private network that IBM designed.
The Bahamas issued a digital currency called the Sand Dollar in 2020, the first CBDC in the world to cover a whole country.
Sand Dollars are backed by both wholesale and retail application structures. The Sand Dollar is not a cryptocurrency. Its network uses multi-factor authentication and digital ID solutions to protect users. Bahamians hold Sand Dollars directly in digital wallets.
The new currency integrates fintech solutions and offers offline functionality for times when communications between the islands are down. With its rapid validation, transactions can be nearly instantaneous. While all of these points sound attractive, the country is still working out some issues with the currency. Not yet widely used, it comprises about 0.1% of circulated currency in The Bahamas as of 2022.
China was the first large country to test the use of a digital currency in 2020. Also called the digital yuan, the eCNY was expected to be commonplace by 2022. Strategically, China pushed the use of eCNY during the recent Winter Olympic Games in Beijing.
The eCNY’s current scalability is about 10,000 transactions per second (TPS), and the country hopes to boost that to 300,000 per second soon.
However, the system still falls short of the capabilities offered by Tenpay or Alipay, which are leaders in the country. In late 2021, there were 261 million wallets associated with the eCNY, and that number doubled by the end of the 2022 Winter Olympic Games.
Furthermore, eCNY isn’t backed by a blockchain. There is a centralized network that is supervised by the People's Bank of China, which is the country's central bank. Unlike the hybrid systems used in some other countries, China's digital yuan is primarily a retail CBDC that’s issued to the public for retail transactions.
France's central bank successfully completed a test program for a CBDC in 2020, and the government plans to continue its testing program for international transactions. The French digital currency was designed for settling interbank transactions. With a digital bond design, the currency was backed with a blockchain. Banque de France partnered with HSBC and IBM to conduct the programs.
Since its wholesale CBDC project showed promising results, the country is also considering a retail structure to potentially offer citizens more payment flexibility and access in the future. As of 2022, the country has not officially made its currency available to citizens.
In early 2022, Canada's central bank announced a collaborative project with the Massachusetts Institute of Technology to develop a digital currency that’s somewhat different in conception from those above. However, there have been talks of developing one since 2020.
Once developed, the CBDC would be a digital version of the existing Canadian dollar. The purpose of developing it, according to the Bank of Canada, is to have a backup currency available if needed. Canada's plans are in place primarily to adapt to changing trends.
South Korea's moves against decentralized finance and cryptocurrency trading have elicited plenty of criticism. Recently, the Bank of Korea (BOK) announced plans to potentially issue a CBDC. However, in the past it has been against the idea.
The BOK aims to use a hybrid system that incorporates wholesale and retail applications for its CBDC. The plans for the central bank digital currency are already serious, and the country is talking about potentially implementing it by 2023 and enforcing rules surrounding it by 2024. However, unlike China's digital yuan, the South Korean digital won would be controlled by a distributed ledger, instead of using a central control structure.
Sweden is currently testing the eKrona, which is a digital version of its standard krona that it began conceptualizing in 2017. The reasons behind launching the eKrona are the declining use of cash and the fear that shifting trends could make state-issued money obsolete.
For Sweden's plans, the CBDC it hopes to issue incorporates a hybrid system that encompasses both wholesale and retail elements. The pilot program uses token verification with transaction history, which could encounter some privacy issues that may violate strict EU privacy laws with the current structure. Any issues related to DLT/blockchain solutions must be solved before the eKrona can be issued to citizens.
While it may sound like CBDCs and stablecoins are similar, they have some distinct differences.
A key difference is that CBDCs are legal tender issued by governments or central financial authorities, to be used as standard currency, and stablecoins are virtual digital assets that are private and tied to a currency. Both types of currencies are digital assets. However, stablecoins use blockchains. Although CBDCs can be backed with blockchains, many are not. Both can support private transactions.
Another main difference between the two is their monetary systems. A CBDC is regulated and monitored by the nation's authorities using a centralized system, while a cryptocurrency isn’t regulated, since it’s decentralized. Another difference is what the currencies achieve. While a CBDC preserves a national banking system's oligopoly, stablecoins democratize global financial systems.
After the unfortunate Terra crash last month, there was much talk about tightening regulations on stablecoins in several countries. In fact, some government leaders said that it was the government's duty to protect citizens from financial disasters. National governments around the world also want to ensure that they can protect their power to control currency.
Governments are looking for ways to regulate crypto stablecoins and limit their power, and regulators have expressed their concerns over a lack of guidelines and rules for stablecoins.
Since cryptocurrencies are growing in popularity, regulators are only going to become more interested in restricting them as time passes. This means that CBDCs will also get more attention as governments look for strategies to keep up with shifting payment and currency trends around the globe.
Along with the testing some countries are conducting, the recent growth in the number of countries that have expressed intentions to develop their own CBDCs are significant factors that show how serious many countries are about central bank digital currencies.
If CBDCs become more common in the near future, they could solve accessibility issues and mitigate some risks of national financial systems if they’re well-designed and work as intended. However, the restrictions that nations want to put on stablecoins, along with the development of those digital currencies, present potential challenges for investors to monitor.
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