This question has been on top of mind for a little while now. The concept has only accelerated as the pandemic has acted as a catalyst for the shift from physical cash in developed economies to alternative payment methods or private cryptocurrencies. As a result, central banks have begun to explore ways to create digital cash in the form of a central bank digital currency (CBDC) and are looking to leverage information on cryptocurrency to do so. A CBDC will act as a digital representation of a country’s fiat currency and will be backed by monetary reserves such as precious metals or foreign currency reserves.
Currently, the standard for cryptocurrencies has been set by bitcoin, the first major digital token in the world today. Bitcoin is a digital currency backed by blockchain technology to allow any two people in the world to exchange value across the internet in a matter of minutes. Due to this unique technological backing, the currency does not need to be regulated by countries or a central bank. This concept runs in direct contrast to the traditional American banks, which have been slow to introduce apps and software that allow peer-to-peer payments, which in part has led to companies like PayPal and Square becoming so successful.
Benefits of a central bank cryptocurrency
Central banks continue to look into the concept of a central bank digital currency for its ability to make payments faster and cheaper. This can be likened to the fact that no traditional banks or other intermediaries would be needed. Transactions could be made directly from the central bank to the end-user. Other applications include the ability to send stimulus funds to households across the United States and help small businesses who have been devastated by the pandemic, regardless of borders. To some extent, this central bank network is already in existence with currency swap lines for foreign exchange (FX) conversions.
Additional benefits of a central bank cryptocurrency are the added insight into the movement of money in the economy. This may help authorities crackdown on money-laundering and terrorist-financing efforts. Already, banks deal primarily with digital representations of an individual’s wealth. However, by creating their own digital currency, central banks will be able to manage the interest rate they are paying and control the general interest rates in the economy.
Risks of a central bank cryptocurrency
Unfortunately, central banks face one major concern when it comes to the creation of their own cryptocurrency. That is, the potential exists for destabilizing the economy and financial markets. The monetary structure designed around digital currencies cuts out commercial banks which rely on retail deposits as their source of funding. To avoid toppling over the current financial structure, central banks must be considered as a complement to cash and other forms of legal tenders. As a result, when topics of central bank currencies are considered, a cap on how much money could be kept by each person in a central bank account follows closely behind.
Currently, there is no country that has officially launched a CBDC, although several pilot programs are in place. Among them are the Bank of England (BOE), Bank of Canada (BoC), and People’s Bank of China (PBoC).
Can we expect a CBDC in the near future?
Since cryptocurrencies have continued to gain in popularity, it is only fitting that central banks look to these examples as the standard to which they will create their own digital currency. However, it is important to consider that these propositions actually run completely contrary to cryptocurrency principles targeted as a hedge for those looking to store their wealth away from central banks.
That said, digital currencies are already being created by central banks and commercial banks with some skepticism that global payments are not as quick or efficient as they could be. As a result, central banks still continue to look for opportunities to adopt new technologies that will help them to revolutionize the global payment area, even if it isn’t a cryptocurrency per se.