Are central bank digital currencies the future of money?
Cryptocurrencies are increasingly becoming part of established economic systems around the world. Financial giant Goldman Sachs now officially views Bitcoin as an asset class and Morgan Stanley recently started offering this cryptocurrency to wealthy clients through its funds.
The central banks of countries including England, Japan, Canada and many others don’t want to let this innovation slip through their fingers and are actively researching the potential of central bank digital currencies (CBDCs). While inspired by Blockchain-based cryptocurrencies, CBDCs differ in key ways.
Digital bank currencies would be directly issued and completely regulated by central banks, fundamentally different to the unregulated nature of cryptocurrencies. Unlike decentralised cryptocurrencies, which have no central organisation that decides who can use the network, central bank issued digital money is controlled by the bank and they have the final say on its circulation.
At the touch of a button central banks could add or remove money to the supply, with Bitcoin having a set limit of 21 million bitcoins that is virtually impossible to increase. The extreme volatility found in many cryptocurrencies would also not feature in digital fiat currencies.
The impact of CBDCs will soon be felt in a growing number of nations as these digital currencies move from the hypothetical stage to everyday usage. It’s not hard to see the benefits of issuing a CBDC. A range of illicit activities could be identified far quicker than today, as the location of every unit of currency is tracked, with tax avoidance, tax evasion and money laundering being almost impossible.
Perhaps most significantly, money transfers and payments would no longer require the use of banks and clearing houses, with real-time transfers being possible. For commercial banks and fintechs, it’s likely that CBDCs will pose challenges to some elements of conventional profit models, especially around transactions and holding deposits.
With interest rates remaining low, some bank customers may seek to shift their deposits to the CBDC due to its perceived security. Besides meeting the potentially complex regulatory requirements around CBDCs, banks may have to offer new services or reduce fees to retain clients who want to move to the new digital currency.
A lot of issues around CBDCs are yet to be addressed and could be extremely complex to resolve. For example, how will each separate CBDC with its own unique regulations interact with each other? Seven central banks have joined a working group that’s aim is to research ways to establish CBDCs that are technologically harmonious. But when there is divergence in policies, which CBDC will win out?
It won’t be long until these questions are answered as the race towards launching a fully functioning, national CBDC is picking up stream. China became the first major economy to issue an CBDC earlier this year, with the digital renminbi currently being tested in a selection of Chinese cities. As cash use continues to fall, it may be sooner rather than later that CBDCs come to be one of the ways used to store and transfer money.
Written by Finbarr Toesland, Editorial Contributor.