Digital currencies backed by central banks, or central bank digital currencies (CBDCs), are becoming a reality for residents in a few countries around the world. The evolution from checks, to debit cards, and now to digital payments give cause to wonder if we really need cash anymore. While economists agree that we still need cash for now, some governments are discussing the effects of implementing a CBDC nationally.
However, not everyone is as interested in the prospect of implementing a nationwide digital currency. Commercial lending and banking would be affected, as the widespread use of CBDCs could take a bite out of commercial deposits and put the industry’s funding in jeopardy. But with China currently developing a digital Yuan, that leaves government and supply chain leaders wondering about the potential trade risks of not competing in the global economy with CBDCs.
Luckily, lawmakers have come up with a slew of solutions that include strict regulations and controls, hard limits on transfers and holdings, and a long-term transition period before the new digital assets could be launched in full effect. In the meantime, central bankers in the US are contemplating adopting their own digital tokens for instant, low friction international transactions.
What is Central Bank Digital Currency?
A CBDC is the virtual form of a certain fiat currency. You can think of it as an electronic record or a digital token of how currency is spent, held, and moved. CBDCs are issued and regulated by central banks and backed by the credit of their issuer. They aren’t really a new kind of money, it just changes the way we track transactions.
While seemingly very similar at first glance, CBDCs are not cryptocurrencies. Cryptocurrencies are digital currencies that are secured by cryptography and exist on decentralized blockchain networks. Bitcoin and other cryptocurrencies are not backed by any government or banking entity and are purely digital currencies. CBDCs, in contrast, are backed by legal tender and are only a digital representation of fiat money.
Part of the draw to create CBDCs is inspired by their crypto-cousins’ distributed ledger technology. DLT, or blockchain technology, refers to the digital infrastructure and protocols that allow access, validation, and continuity across a vast network. This means that, in contrast to fiat currency that exists today, digital currencies can be tracked and verified in real-time, limiting the risk of theft and fraud.
Blockchain technology is usually associated with cryptocurrency, but it has the potential for numerous applications that could help governments organizations and banking entities run more smoothly with accountability and transparency. Another reason why countries are drawn to CBDCs is they have the ability to help increase banking access for otherwise underbanked populations.
Currently, there are 81 countries exploring CBDCs. China is racing ahead of the pack with their development of the digital Yuan, putting pressure on countries that will want to remain competitive. It raises the question of whether China will at some point accept only digital currency, meaning other countries would need their own CBDCs to remain competitive on a global scale.
China’s digital Yuan
China has long been known to resist cryptocurrencies and crypto trading, so when the news broke that their central bank has been developing a CBDC there was some confusion. However, it has now become clear that the Chinese government is creating an environment where citizens who want to use digital currencies like crypto will have to use the digital Yuan, removing any competition from DeFi banking initiatives.
Before their crackdown on Bitcoin and crypto, local investors made up 80% of the crypto trading market. This shows promise when it comes to the adoption of the digital Yuan, with so many Chinese citizens open to adopting and spending digital currency.
They have already started real-world trials in a number of cities and are expecting the digital Yuan to increase competition in China’s mobile payments market. It is still not entirely clear how users will hold and spend the new digital Yuan whenever it is available nationwide. Right now the most popular form of mobile payment in the country relies on QR codes scanned by merchants.
Alipay and WeChat Pay could eventually integrate CBDC functionality, and smartphones could also potentially be used as a digital wallet for CBDCs. There is still a lot to be discussed, tested, and fixed before the digital Yuan can be distributed nationwide, but China is currently the country closest to rolling out its own CBDC.
Where does the United States stand?
Crypto thefts, hacks, and frauds amounted to about $1.9 billion in 2020, so many leaders have reservations when it comes to enforcing and regulating CBDCs in the US. But there is evidence that CBDCs would have no issues being adopted by the American people. Crypto aside, the digital payments sector is booming with about 75% of Americans already using digital payments apps and services.
But there is not yet a single widely accepted infrastructure available that could handle CBDCs, and lawmakers are lagging behind when it comes to regulations for fintechs as it is. The US could take a page from China’s book and explore adding CBDC functionality to existing banking fintechs like Chime, Paypal, and ApplePay. According to online trader Gary Stevens from Hosting Canada, it would also be wise to look at banks that offer trading services as well.
“In the US, banks offering online trading services (such as Merrill Edge through Bank of America) tend to provide a seamless client experience,” says Stevens. “They strive to provide a consistent login interface between the bank and its brokerage arm, making switching between these platforms easier. This also makes other tasks like moving money between these accounts more flexible. Therefore, US residents have come to expect a more integrated, holistic experience with similar core functionality.”
The Future of CBDCs
The onset of the pandemic has created the perfect storm for CBDCs to come to fruition. Telework, online education, and streaming services have experienced growth while brick-and-mortar establishments have suffered. The same is true for the financial services industry. Banks have struggled to compete with fintech solutions, and more people are utilizing digital payments than ever before.
Since CBDCs are such a new technology, there is still much to learn when it comes to implementing CBDCs nationwide and around the globe. Offline accessibility and resilience are only a couple of concerns regarding digital currency adoption worldwide. Other issues include user privacy, using private and public blockchain networks, and how digital currencies will be exchanged on a global scale. Only time will tell how central banks choose to seriously pursue this route to make it more mainstream.
There are a lot of details still up in the air regarding CBDCs, as well as a considerable amount of research, testing, and development left to unfold. But one thing is clear: central bank digital currencies are already under development. Whether you are getting into online trading or just like the convenience of e-payments, they might be coming to a digital wallet near you sooner than you think.