By Husnal Thukral
At the epoch of digitalisation, the financial architecture worldwide is on the verge of a monumental change. Central Bank Digital Currencies (CBDCs) — the digital embodiment of fiat money issued by the central bank — are standing at the cusp of this digital currency revolution by changing the way individuals transact and manage money. By promising transparency, enhanced efficiency, heightened safety, and financial inclusion, they are not only going to completely transform the banking sector but also restructure the broader business landscape. As central banks globally wrestle with the implications, challenges, and opportunities of this modern day currency, a significant shift of the world is imminent. In 2023, the landscape of CBDCs is diverse, with countries at various stages of development and implementation. This article explores the current state of CBDCs, their potential implications for the banking and business sectors, and the challenges and opportunities that lie ahead.
As of 2023, there are 130 countries that are exploring the idea of CBDCs, some of which have already launched their own versions of it. A few countries — Nigeria, the Bahamas, and the Eastern Caribbean Currency Union — are leading the pack and have effectively and completely implemented this digital currency. The United Kingdom and Canada, on the other hand, are in their research and development phases. These 2 countries are visibly more cautious towards CBDCs and are investing in Blockchain technology in order to optimise their banking processes before they take any concrete deciding steps. Lastly, China, who is not known for prioritising their consumer focused developments in the past, is taking significant steps to replace their bank notes with this digital form of currency, and transactions using e-CNY (their version of CBDCs) hit 1,8 trillion yuan in June 2023.
Insofar, most of the 130 countries are still in their development or pilot stages of their CBDC projects, so this digital currency is still in its infancy. However, its transaction value is forecasted to grow by a tremendous 260,000% by 2030. This illustrates its ability to fully transform the financial and business sectors by allowing for more rapid, efficient, and secure transactions.
The introduction of a new digital economy to the world will completely revamp the financial system and reshape the financial services that we know today. They have the ability to streamline payment systems, significantly reduce transaction costs through eliminating the intermediary, and concretely assist in the process of financial inclusion. There are two sides of the same coin, however, as this reorganisation poses a considerable threat to the traditional banking system. Since central banks will directly be issuing this form of currency, they would be bypassing commercial banks. Thus, they could eventually marginalise the role of joint stock banks in the financial ecosystem and by longshot make them redundant. CBDCs will essentially be holding all deposits for the public, without interest. This could lead to fewer people choosing to deposit their savings in commercial banks. Consequently, commercial banks may not be able to lend as much. The CBDC model assumes that every individual in the country has enough savings to let go of their need for banks and loans.
CBDCs introduction and implementation offer a myriad of opportunities for the business sector’s growth and development as well. They would allow businesses to make transactions directly and instantaneously; therefore, potentially revolutionising supply chain management entirely, aiding in reducing payment friction, and enhancing cross border trade. However, businesses will still have to navigate through the obstacles of adapting to a new technology like this. Additionally, to ensure data security and to comply with the emerging regulatory framework that comes with this form of currency is going to be challenging.
It is important to ask — with the existence of cryptocurrency, what is the need for CBDCs?
Much like cryptocurrency, CBDCs will make use of a digital ledger, in order to store and record information about each transaction. However, unlike cryptocurrencies, CBDCs are centralised. Decentralisation of the blockchain ecosystem promotes greater governance as no one individual or entity has the jurisdiction to overlook the transactions in the ledger. So, CBDCs will significantly reduce transparency and eradicate anonymity as the government will have full visibility of the digital ledger and the transactions recorded within it. It will allow governments to track individuals, as the ledgers may reveal their locations, which is beneficial to track convicts but is a violation of human rights and privacy of the citizens who are impacted by this. Although CBDCs will aid in the regulation of the money supply (which has been difficult since the “cashless” trend), their purpose and approach is debatable as it gives the government complete power over the public’s money. This leads one to ask are the governments trying to gauge control over the aspect of finance that they are unable to control? Are they intimidated by the success and potential of cryptocurrency?
So, should individuals be worried about the introduction and spread of CBDCs?
In short, yes. As its implementation will allow governments globally to control and manipulate public money in accordance with their own political agenda. The example of the Canadian government temporarily disabling the bank accounts of several individuals who were involved in the truck protests in 2022 perfectly supports this point. The truckers’ right to protest goes hand in hand with their right of freedom of speech and action. So, if the Canadian government was able to freeze their bank accounts with a few phone calls, imagine how easy and instantaneous it would be if widespread adoption of CBDCs had already occurred. Individuals using this form of currency will have to adhere to the way of the government. Therefore, its implementation potentially challenges and threatens democracy.
With the rapid decrease in demand for banknotes and coins, in order to preserve access to public money the implementation of CBDCs is vital. Although this form of digital currency promises numerous benefits, if it is not well-designed the negative ramifications within the macro level of business are unavoidable. They could potentially create obstacles for various aspects of the financial and business systems, as by engendering change to retail and wholesale payments, and cross-border transactions they could have a negative spillover effect on the implementation and effectiveness of a country’s monetary policy. For instance, retail CBDCs may lead the public to shift their holdings from cash to CBDC deposits, impacting the velocity of money, reducing reliance on bank deposits, and increasing volatility in commercial bank reserves held at the central bank. If these changes are significant, they can undermine the traditional channels through which the monetary policy affects credit and interest rates. This, in turn, can hinder the central bank’s ability to predict reserve levels and conduct Open Market Operations effectively, ultimately weakening the efficacy of monetary and inflation targeting regimes. Furthermore, the tokenization of wholesale CBDCs could potentially create divisions within financial markets, leading to unfavourable repercussions for liquidity management and interest rate transmission. The use of CBDCs in cross border transactions could lead to currency substitution (when international or foreign currency becomes more widely used, as compared to domestic currency). This would reduce the ability of domestic monetary authorities to manage monetary and exchange rate policies effectively, especially during a financial crisis as it would cause faster reversal of capital flows.
In essence, as we navigate the uncharted waters of CBDCs, the banking and business sectors must be proactive and careful while adapting to the changing financial landscape. The potential of CBDCs to transform global finance is immense, but it requires collaboration among governments, financial institutions, and businesses to address the associated challenges and to unlock the full potential of digital currencies. It is additionally important to vary the privacy issues that its implementation brings. Its rise marks a pivotal moment in the evolution of digital finance, offering a glimpse into the future of money.
The views expressed in this article are the author’s own, and may not reflect the opinions of The St Andrews Economist.
