The benefits of central bank digital currencies (CBDCs) include revolutionizing payments and providing faster payment efficiency, as well as improving financial inclusion.
At the beginning of 2020, the majority of countries were already in the process of investigating CBDCs, with several banks planning to issue their version within three years. The far-reaching implications of the global pandemic pushed these plans ahead, highlighting the need for greater financial innovation and inclusion.
Helped by distributed ledger technology (DLT), nations have made varying degrees of progress with regard to their digital currencies — from initial research to pilot programs.
The main design choices for CBDCs include:
Wholesale — this design would be utilized by commercial banks or clearing institutions for securities settlements interbank payments. One example is Project Stella, a joint effort by the European Central Bank and the Bank of Japan. The project is studying the use of DLT and its implications on financial market infrastructures.
Retail — a retail design would act as a replacement or complement to a country’s paper currency. Within retail CBDC, the architecture designs are numerous, as the lines between commercial and central banks begin to blur. As a direct CBDC, the central bank handles the retail payments, while a hybrid scenario has several different options regarding payments, onboarding, and claims.
Both the public and private sector offer their own strengths — with the central banks providing regulatory and supervisory functions, while the private sector would supply the innovation and data management.
The rapid progress of CBDCs has caught the eyes of regulators as well. The International Monetary Fund, World Bank, and G20 countries announcedthey were working together to establish standards for the regulation of CBDCs.
Along with the Bank for International Settlements, the groups plan to complete the selection of CBDC designs, technologies, and experiments by the end of 2022.
In the United States, the Federal Reserve is active in the international conversation. The central bank has been conducting private experiments on the benefits of digital currencies as well as the implications on the financial system.
In August, the Fed announced that it was assessing the role of a digital dollar with researchers from the Massachusetts Institute of Technology to develop an experimental digital currency and better understand the technology behind such a system.
However, the U.S. is more concerned with getting the technology right. At a recent IMF conference, Fed Chair Jerome Powell spoke about a U.S. backed digital currency, stating it was:
“more important to get it right than to be first.”
In contrast, China has been working on a digital currency since 2014 and recently tested its digital currency with the general public. Roughly 2 million people signed up for a recent trial in Shenzhen, which rewarded testers with 200 DC/EP (digital currency electronic payment).
And, in what could be the first of its kind, Huawei’s new smartphone comes with a built-in hardware wallet for the digital yuan. The smartphone is equipped with hardware security, anonymity, and may be capable of initiating transactions offline.
If adopted broadly as a system to streamline trade and reduce risk, will China become the world’s trade banker, as well as its factory? China may become the first major central bank to issue a CBDC, but it is also taking the most significant risk. According to Mark Williams, Master Lecturer in Finance, Questrom School of Business, Boston University:
“If the Peoples Bank of China is able to create a customer-facing digital currency that is easily accessible, fast, reliable, cost-efficient and safe, they will set an important standard and clear path forward for other sovereigns. However, if it fails, it will set back the momentum towards CBDCs.”
The largest beneficiaries of a digital currency may be emerging countries, as a digital currency could provide a useful financial means to assist in non-banked and underbanked countries. A CBDC could help solve the issue of inequality in third-world countries, and help with central bank policy. Williams added that:
“CBDCs could also help in money transmission and provide more effective monetary policy.”
Prior to the pandemic, many emerging economies were researching and testing CBDCs. The pandemic’s social restrictions hastened these plans in several nations.
The Bahamas became the first country to launch a sovereign digital currency on Oct. 20, although the currency is currently restricted to use within the country. With just under 400,000 people, the sand dollar was designed to provide people and businesses in some of the island nation’s far-flung locales with better access to financial services.
Cambodia launched its blockchain-based Bakong system on Oct. 30, while Lebanon has plans for 2021. The East Carribean Central Bank, the monetary authority for eight islands in the Caribbean, is also in advanced stages of issuing a CBDC.
In the coming years, will the role of central banks change as countries around the world continue to develop and investigate their options of a sovereign digital currency? With so much at stake, it is no longer a matter of if a country will issue a digital currency, but when.
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