Central bank-backed digital currencies, or central bank digital currencies (CBDCs), are becoming a reality for residents of a few countries around the world. The evolution from checks to debit cards and now to digital payments begs the question whether we really need cash. While economists agree that we still need cash for now, some governments are discussing the effects of implementing a CBDC nationwide.
However, not everyone is equally interested in the prospect of implementing a digital currency nationwide. Commercial loans and banking services would be affected, as widespread use of CBDCs could reduce commercial deposits and jeopardize industry funding. But with China now develop a digital Yuan, which leaves government and supply chain leaders wondering about the potential business risks of not competing with CBDCs in the global economy.
Fortunately, lawmakers have come up with a host of solutions that include strict rules and controls, strict limits on transfers and holdings, and a long-term transition period before new digital assets can be fully launched. In the meantime, central bankers in the United States are considering 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 money is spent, held and moved. CBDCs are issued and regulated by central banks and backed by the credit of their issuer. It’s not really a new kind of money, it just changes the way we track transactions.
Although seemingly very similar at first glance, CBDCs are not cryptocurrencies. Cryptocurrencies are digital currencies secured by cryptography and existing on decentralized blockchain networks. Bitcoin and other cryptocurrencies are not backed by any government or banking entity and are purely digital currencies. CBDCs, on the other hand, are legal tender and are only a digital representation of fiat money.
Part of the raffle to create CBDCs is inspired by their crypto-cousins distributed ledger technology. DLT, or blockchain technology, refers to the digital infrastructure and protocols that enable access, validation, and continuity over a large network. This means that unlike fiat money that exists today, digital currencies can be tracked and verified in real time, limiting the risk of theft and fraud.
Blockchain technology is commonly associated with cryptocurrency, but it has the potential for many applications that could help government organizations and banking entities operate more easily with accountability and transparency. Another reason why countries are drawn to CBDCs is that they have the capacity to help increase banking access for otherwise underbanked populations.
Currently there is 81 countries explore CBDCs. China is leading the pack with its development of the digital Yuan, putting pressure on countries to remain competitive. This raises the question of whether China will at some point accept only digital currency, which means other countries would need their own CBDCs to remain competitive globally.
Chinese digital yuan
China has long been known for resist cryptocurrencies and crypto trading, so when news broke that their central bank was developing a CBDC, there was some confusion. However, it has now become clear that the Chinese government is creating an environment in which citizens who wish to use digital currencies like crypto will have to use the digital yuan, thus removing all competition from DeFi banking initiatives.
Before their crackdown on Bitcoin and crypto, local investors represented 80% of the cryptocurrency market. This is promising when it comes to digital yuan adoption, with so many Chinese citizens open to the adoption and use of digital currency.
They already have started real world trials in a number of cities and expect the digital yuan to increase competition in the Chinese mobile payments market. It is still unclear exactly how users will conserve and spend the new digital yuan whenever it becomes available nationwide. Currently, the most popular form of mobile payment in the country relies on QR codes scanned by merchants.
Alipay and WeChat Pay could potentially integrate CBDC functionality, and smartphones could potentially be used as a digital wallet for CBDCs as well. There is still a lot to discuss, test and fix before the Digital Yuan can be distributed nationally, but China is currently the closest country to deploying its own CBDC.
Where is the United States at?
Crypto thefts, hacks, and frauds amounted to around $ 1.9 billion in 2020, so many executives have reservations about the application and regulation of CBDCs in the United States. But there is evidence that the CBDCs would have no problem being adopted by the American people. Aside from crypto, the digital payments industry is booming with around 75% of Americans already use digital payment applications and services.
But there isn’t yet a single widely accepted infrastructure available that could handle CBDCs, and lawmakers are lagging behind when it comes to fintech regulation as it is. The United States could take a page from the Chinese book and explore adding CBDC functionality to existing banking fintechs like Chime, Paypal, and ApplePay. According to online merchant Gary Stevens of Hosting Canada, it would also be wise to look at the banks that offer trading services also.
“In the United States, banks offering online trading services (like Merrill Edge through Bank of America) tend to offer a seamless customer experience, ”says Stevens. “They strive to provide a consistent connection interface between the bank and its brokerage arm, making it easy to switch between these platforms. It also makes other tasks like transferring money between these accounts more flexible. Therefore, residents of the United States expect a more integrated and holistic experience with similar core functionality.
The future of CBDCs
The start of the pandemic created the perfect storm for CBDCs to happen. Telecommuting, online education and streaming services have grown while physical establishments have suffered. The same goes for the financial services industry. Banks have struggled to compete with fintech solutions, and more people than ever are using digital payments.
Since CBDCs are a whole new technology, there is still a lot to learn when it comes to implementing CBDCs nationally and around the world. Offline accessibility and resilience are just some of the concerns about digital currency adoption worldwide. Other issues include user privacy, the use of private and public blockchain networks, and how digital currencies will be traded globally. Only time will tell how central banks choose to seriously pursue this path to make it more common.
There are still a lot of details in the air regarding CBDCs, as well as a considerable amount of research, testing and development to be deployed. But one thing is clear: central bank digital currencies are already in development. That you are get into online commerce or just like the convenience of electronic payments, they might arrive in a digital wallet near you sooner than you think.