Central Bank Digital Currency: An Overview of What’s Known So Far
Central bank digital currency (CBDC) is fiat money—or money established/backed by a government through its central bank—in a virtual form. It combines the power of blockchain with the logistics of distributed ledger technology (DLT), where data can be synchronized across multiple locations without the need of centralized storage.
And as cryptocurrency’s existence continues to persist despite the skeptics and its adoption continues to grow—validating virtual currency—the emergence of CBDC is becoming more concrete.
In many ways, this is a two-way street where CBDCs can serve almost as “training wheels” to ease more people into cryptocurrency adoption, and to create the systems needed to more easily handle cryptocurrency transactions. If people see virtual currency issued by their banks, more people will be open to the idea of cryptocurrency; and if banks build the systems for holding and transacting with CBDCs, they’ll be able to handle non-central bank issued digital currency—cryptocurrencies like Bitcoin and Ethereum.
The fact that we are even able to discuss CBDC is a testament to just how fast things move in finance and economics. Merely three years ago, former Federal Reserve Chairman Alan Greenspan told CNBC, “Bitcoin is really a fascinating example of how human beings create value, and is not always rational… It is not a rational currency…”
Contrast that to how, late in 2019, Philadelphia Fed President Patrick Harker told Reuters that the issuance of digital currency by central banks including the Fed and the European Central Bank (ECB) is “inevitable.” And while Harker himself said he was still “in the minority” on the issue, that doesn’t mean he’s wrong about CBDC’s inevitability.
In a 2018 study by the Bank of International Settlements, 70% of the central banks that responded reported that they are working on some form of digital currency research or implementation.
Now, with rollouts and plans for rolling out central bank digital currencies (CBDC) in several countries including Sweden, France, and even China, this idea has grown from a backroom research project into something with real world implications. The National Bureau of Monetary Research has looked at CBDC from the perspective of monetary policy and decided it could facilitate transparency through its built-in methods of accounting.
Understanding what CBDC is, how it compares with other nongovernmental cryptocurrencies, and what the future may hold is important for everyone to understand, even if you aren’t personally buying and holding digital currencies; the emergence of CBDC is going to become a hot topic, and will affect existing fiat currency. And if you do already own crypto, you’ll also need to understand how CBDC will operate as another currency player and potential source of financial regulation.
Since you’re going to hear about it more and more in the news, we wanted to help give you some background knowledge and some details on what to expect.
Key Characteristics of Central Bank Digital Currency
Central bank digital currency, on the surface, is straightforward: it is a form of currency issued directly by a central bank to both supplement its paper currency and to compete with cryptocurrencies like Bitcoin.
CBDC would fit in as part of a country’s monetary policy, or how a central bank controls the flow of money and the rates associated with currency, cognizant of the impacts their decisions have on everything from production through prices and even employment.
The idea of CBDC isn’t a new one. From the moment the enigmatic founder of Bitcoin Satoshi Nakamoto published his 2008 whitepaper on cryptocurrencies and blockchain technology, the idea of a more formal adoption of the technology started to pop up.
But only in 2015, when the Bank of England first discussed the concept of a central-bank-issued version of digital currency, did other financial institutions and regulatory bodies really start paying attention.
While the dozens of central banks around the world are looking at different forms of CBDC to potentially implement, all versions of digital cash being considered all share some aspects:
- Centralized – Like the common currencies we all use, CBDCs are regulated top-down. This alone is a giant differentiation between CBDCs and most cryptocurrencies, which operate as a decentralized network.
- Supplemental Currencies – Central banks around the world view digital currency as something with potential benefits to augment existing currency, not as a replacement. As of now, digital currency hasn’t replaced any other legal tender in the world. Notes and coins will remain intact for the foreseeable future.
- Deterrent to Illicit Activity – One of the major reasons why central governments like the Fed would even consider issuing digital currency has to do with how CBDCs, for the most part, are designed to be traceable. This means it will be difficult for them to be used for illegal purchases and money laundering schemes.
- Form of Governmental Savings – The 2019 U.S. Treasury budget for printing and minting paper dollars and coins was nearly $1 billion. Yet the number of cash transactions has continued to fall. Digital currency would offer a significant savings over these operational costs.
- Speed – Many central banks are looking at CBDC just as a way to bypass formal minting processes and speed up transactions. John Rolle, the head of the Central Bank of the Bahamas, said that the rollout of its CBDC called the “Sand Dollar” is in part an effort to speed up financial recovery after hurricanes. Additionally, digital currency facilitates real-time payments and deposits.
- Tool For Financial Stability – As we’ve seen in the past few decades, central banks have been using every tool at their disposal to prop up their currencies and economies, from drastic rate cuts to quantitative easing and even “helicopter money.” CBDC would give them even more control over these types of programs, and another tool in their toolbox to help during an economic downturn.
Of course, if it were easy or straightforward, we’d already have CBDC everywhere. The implementation of such a large idea does come with its own challenges.
Challenges Facing CBDC
The largest problem with large-scale implementation of CBDCs is that no one is 100% sure they know how the CBDC will work, practically speaking, and so it feels risky; paper money feels safer because it’s been in use for ages, in some form or another, and it’s physically tangible.
Here are some of the specific challenges that arise in discussions about CBDCs:
- Banking System – CBDC could potentially open up direct central bank accounts for millions of people all at once. The fear that this would replace a portion of the current private banking system is a real threat, especially since we’re just about a decade removed from the last major global financial crisis.
- Definition of Money – Central banks worry that CBDC could replace traditional currencies too quickly, actually leaving them with fewer tools—rather than more—in the long run that they could use to combat economic fluctuations.
- Role of Central Banks – The implementation of CBDC could drastically alter what the likes of the US Federal Reserve and the ECB actually do. It would force central banks to come up with competing fees and infrastructure that solely reside with private banks today.
- Give Legitimacy to Cryptocurrencies – A long-held fear for many in the central bank community is that the likes of bitcoin could tear monetary control away from them. Adding a competing digital currency could actually aid in the legitimacy of cryptocurrencies for everyday transactions.
- Cross-Border Payments – Even if a country decides to adopt CBDC internally, it might have limited functionality if it can only function domestically. The lack of ability for a potential CBDC to participate in cross-border payments is one symptom of its limited acceptance, capping its functionality and adoption. This is also another key differentiator from cryptocurrency, which has no borders. Lack of cross-border payments also limits financial inclusion.
While you can argue for or against any of these challenges, central banks aren’t exactly known for their boldness and swiftness of action. These will remain impediments even as they continue studying and testing their own CBDCs.
Where CBDC Stands Today
As noted, most central banks remain in the study phase when it comes to digital currencies. But over the last year or so, as central bankers have been proactive about researching and discussing the implications of digital currency, there has been some to progress past that point.
Here is the quick rundown on where various central banks are on the implementation of CBDC within their systems of monetary policy:
- China – This is the largest and most important test for CBDC. The country with the world’s largest population announced in 2019 that by early 2020, its central bank, the People’s Bank of China (PBOC), will be testing out its own “Digital Currency Electronic Payment” (DCEP). Nicknamed the “digital yuan,” the currency is China’s answer to cryptocurrency, which the country continues to rule illegal to trade. News outlets report that, fearing Libra’s penetration despite its ruling, the PBOC is pushing up its release of DCEP.
- Sweden – One of the early testers of CBDC, Sweden’s central bank, the Riksbank, has been monitoring its “e-krona.” In response to a rapid drop in the use of paper currencies, the Swedish government has now announced another pilot program for a new platform for its e-krona.
- Uruguay – Praised by the IMF, the Central Bank of Uruguay ran a pilot program for its “e-peso” from November 2017 to April 2018. The program was a success, but larger-scale implementation hasn’t been announced.
- Turkey – After out-of-control inflation in 2018 and 2019, Turkey’s central bank has decided to test and roll out a “digital lira” sometime in 2020. This will be a significant test as other central banks and regulatory agencies see how CBDC might aid or exacerbate a currency in crisis.
- Saudi Arabia and United Arab Emirates – Late in 2019, leaders of the two wealthy Middle Eastern nations agreed to try out a joint-issued CBDC named “Aber.” It will go into testing at select banks at some unknown date.
- France – The eurozone member announced in December that it will begin a pilot program for the first digital euro project during the first quarter of 2020. This too was in response to the early anticipation and controversy surrounding Libra.
What’s Next For CBDC?
While neither the ECB nor the U.S. Fed have initiated any direct plans for testing or rolling out their own CBDC, many are waiting for one or both to act. As you can see, however, there are other programs already in place or even completed elsewhere. What comes next is still up in the air.
If early successes from Uruguay and Sweden are any indicator, further small-scale programs are likely the first step. This will help central banks determine the appetite for a digital currency.
From there, the next logical step would be to cross test other forms of CBDC. Sweden’s e-krona, for instance, is “value-based,” which is similar to tokens common in decentralized crypto markets. However, the country is considering a more “account-based” version, which would directly take on the private banking system.
Whatever steps individual central banks decide to take next, CBDC isn’t going away any time soon. The results from the early testers, combined with competition from cryptocurrencies, and the potential benefits listed above will keep CBDC on everyone’s radar. And anyone with an interest in crypto should keep an eye on CBDCs; as they grow in adoption and usage, they can help set the stage for more widespread adoption of cryptocurrency.