In recent months the idea of Central Bank Digital Currencies has been gaining foothold in the cryptocurrency space. First introduced in China, in the form of the digital yuan, more governments are either considering to build their own digital assets or are already in the process of building these complex frameworks. Along with China, six other countries also have operational centralised digital currencies while others like Russia, Sweden, Estonia and Palestine will soon be launching theirs. The US is however playing it cautious. Jerome Powell, the chairman of the Federal Reserve, has said that America would prefer to “get it right than to be first” with a digital currency.
So what are Central Bank Digital Currencies (CBDCs) and How do they Differ from Other Cryptocurrencies?
In a news report, economists explain: “CBDCs are simply a digital version of cash—the physical money issued by central banks. In most countries, their design will probably resemble existing online payment platforms, with one key difference: money held on a CBDC app or website will be equivalent to a deposit at the central bank.”
CBDCs thus differ from private digital currencies in terms of centralisation. While private digital cryptocurrencies are structurally decentralised, the supply and flow of CBDCs are designed to be controlled by the central banks, much like physical cash.
What’s all the hHype about?
Now while some might cringe at the idea of centralised control of digital currencies, since that is one of the issues that private digital currencies were supposed to solve, CBDCs do have their benefits.
These were explained broadly by IMF Deputy Managing Director Tao Zhang in a Keynote Address on Central Bank Digital Currency in the London School of Economics delivered on February 28th.
He highlights five major benefits:
CBDCs offer a unique opportunity to reach people who for one reason or the other cannot access payment systems due to geography or prohibitive costs. With a digital currency such people can access banking facilities from their smartphones.
CBDCs will provide people with a means of payment without necessarily requiring them to have a working bank account.
Fintech industry is dominated by a few corporations. CBDCs will help open the field to other players so as to encourage fair competition.
‘CBDCs could be used to charge negative interest rates and thus help alleviate the constraint on monetary policy transmission due to the “effective lower bound.”’
This is perhaps the most important point. The main idea behind CBDCs is to counter the growing use of private digital currencies. Centralised digital currencies are designed to offer a more regulated and thus more stable financial asset for investment.
With that said, a centralised digital platform does raise questions about the amount of control that central banks will have over citizens. China, for instance, already has a social credit system where it imposes certain bans on people deemed to have ‘behaved badly.’ Coupled with CBDCs, which China has been at the forefront of, the government could effectively restrict access to someone’s cash whenever it sees fit.
CBDCs do offer a unique opportunity for growth and innovation in an industry that has been lagging behind in such. However, there is a need to proceed with caution lest we end up with systems that take away freedoms that are key to a functioning society.