In this article you will get to know what does Central Bank Digital Currency phrase really mean, why it is important and what can we expect in the future of this technology. I will try to be as clear as possible as but sometimes technical and economical phrases are required.
Central Banks have been considering to issue some kind of digital currency since the late 20th century. In the last couple of years the debate about digital currencies started the shift from a mainly theoretical and subsidiary topic to a realistic alternative of the current fiat money which can be introduced basically whenever a central bank is ready to take this huge leap into the unknown.
Why do we need it - a general overview
What changed in the last century or so that we could be this close to a monetary evolution or even a possible revolution? There are a handful of reasons why we are closer than ever to CBDCs, like
- Declining use of cash in the developed world,
- The financial sectors interest in technological innovations, thanks to
- Increasing attention to private digital coins (eg.: Bitcoin) and
- Emergence of new threats in the industry as there are many serious new player entered the financial sector successfully with huge technological advantages (eg.: Revolut, Transferwise, etc.)
I can safely say that the current banking industry is a very robust, complex and outdated in many ways. They realized this a long time ago, but as all the non-central banks were getting more and more profits every year, they did not need to have any kind of disruptive initiative. The above mentioned alternatives for the traditional banks are growing their popularity exponentially day by day and the banks are already failed to react and even if they did there is not much they can do due to strict regulations and their current way of conducting business.
Definition and Features
Back to the topic at hand, CBDC is not a well-defined term as it refers to a number of concepts. But all of them envision it to be a new form for of central bank money. So it is a liability to the central bank, which serves as a medium of exchange and store of value while still being denominated in an existing unit of account, like dollar or euro. I must mention that central banks actually have something called reserve and settlement accounts which already fulfills the above mentioned definition. These accounts are not considered CBDC and I will not cover that topic in the article.
To create a CBDC there are many features that needs to be considered, because these currencies are not "one size fits all". The two major type of CBDC can emerge, general purpose or wholesale, the first one aims for being an "e-cash" available for everyone while the wholesale type is designed for the needs of the financial sector only. Both of these should have different attributes but in this article I just wanted to indicate them. Every design choice will have serious implications for financial stability, payments and monetary policy. The most important features to consider are: availability, anonymity, transfer mechanism, interest-rate, limit.
Transfer mechanism - should it be a peer-to-peer solution only issued by the central bank (just like cash). If so, then should it be directly issued to the people or through their bank. If not peer-to-peer then the system will have intermediaries for transfers but will there be only commercial banks for that or other agents too?
Interest rate - CBDC can be governed be interest rate policies as other form of money. But is it necessary? If, so now the central bank can set is up to have negative interest rate, which forces people to use it and its a great tool to prevent recession.
Limit - Should the amount of CBDC have any limit? If so would it be best to have a fix limit or have limit on possible token minting per day for example?
All of these features can highly influence how will the CBDC look like, I think there is no right or wrong answer if the goals is matched by the features. It is interesting that most central banks will have different methods as most concept I saw were really unique in some aspect.
Challenges
While having a huge potential in the technology many questions arise when it comes to actual usage. Most importantly legal considerations, cyber-security, privacy which as I previously mentioned causes AML/CFT concerns (Anti Money Laundering, Combating the Financing of Terrorism). For a central bank to successfully implement a CBDC they have to be very thorough in all of these areas while not going too crazy to have a viable, efficient, secure and digital alternative for the fiat money. These challenges are some of the biggest reasons why currently there are no live CBDCs in use but as more and more studies, projects and tests are conducted all over the world we are getting closer and closer to a world where CBDCs will play a major role in our monetary system.
Summary
CBDCs are the way for central banks to innovate the financial sector from a top-down perspective. The technology is ready for implementation, so with the right goals and features which find solutions for the challenges it can become the start of a new era in the monetary system moving away from the outdated fiat based system.
I think we still have some years for a worldwide applications but we can clearly see that there are many projects and tests running under different central banks, like the e-yuan in China (see more in this article).