The Promise of Central Bank Digital Currencies

Nov 8

Central bank digital currencies (CBDCs) are one of the most exciting innovations in finance and technology today. CBDCs are a form of digital currency issued and backed by a nation's central bank. While cryptocurrencies like Bitcoin operate independently, CBDCs would operate more like physical cash, only in a digital format.

CBDCs have the potential to bring major improvements to a country's financial system and overall economy. According to the Central Bank Digital Currency Tracker by Atlantic Council, 130 countries, representing 98 percent of global GDP, are exploring a CBDC. A new high of 64 of these countries are in an advanced phase of exploration [1].

Here are some of the key benefits CBDCs could offer:

Faster, Cheaper Payments

One major advantage of CBDCs is they can make payments faster and more efficient. CBDCs run on blockchain or other digital ledgers, allowing instant transactions without middlemen. This removes the need for intermediaries like banks and payment processors that often slow things down and charge fees [2]. According to the Bank for International Settlements, CBDCs can lead to "lower transaction costs and faster settlement times." [2] With CBDCs, money transfers could happen instantly between parties, even internationally. This disruption could greatly improve efficiency and accessibility for consumers and businesses alike.

Greater Financial Inclusion

CBDCs also hold promise for increasing financial inclusion for the 1.7 billion adults globally who are unbanked [3]. Because CBDCs are digital, people don't need a bank account to use them. Consumers access CBDCs through digital wallets on their phones or other devices.

As Ripple explains, "Retail CBDCs can help the unbanked and underbanked by establishing a more inclusive digital payments ecosystem and creating financial data identities." [4] By expanding access to digital payments, CBDCs can help unbanked populations participate more fully in the economy.

Enhanced Security

As digital currencies, CBDCs can be designed with state-of-the-art cryptography and security protocols. Cryptographic techniques can protect CBDC transactions and user data via encryption [5]. Blockchains and centralised ledgers also enable greater transparency and traceability for CBDCs compared to physical cash. These features help prevent fraud, money laundering, and other financial crimes [6].

According to PwC, CBDCs can be designed to be traceable, which can aid in anti-money laundering (AML) compliance procedures and investigations. The transaction history for CBDCs is also fully traceable, which can help prevent fraud and other illicit activities [6]. This advanced security improves integrity across the financial system.

Economic Growth Potential

By enabling faster, more efficient transactions, CBDCs can stimulate economic activity and growth. A survey by Gartner found that nearly 70% of banking executives believe CBDCs can moderately or significantly boost GDP growth [7]. CBDCs also expand digital payment capabilities for businesses and consumers.

As Ripple notes, "CBDCs can contribute to economic growth by making it easier for businesses to make payments and by providing access to financial services to more people." [8] The innovation of CBDCs provides a foundation for greater prosperity.

Risks of CBDCs

Of course, CBDCs also have some potential risks. Here are some of the main concerns surrounding CBDCs:

Cybersecurity risks: CBDCs are a target for cyberattacks, as they hold the potential to disrupt financial systems. A UK House of Lords economic affairs committee report concludes that CBDCs pose security risks, including individual risks and risks to the financial system [10].

Privacy concerns: CBDCs could be used to track people's spending habits, which could raise privacy concerns. CBDCs could lead to a system that can be monitored by law enforcement and intelligence agencies while not allowing offline peer-to-peer transactions, which could be undemocratic and dangerous [11].

Power over financial systems: If CBDCs are widely adopted, they could give central banks too much power over the financial system. CBDCs could undermine financial markets by reducing credit availability, disintermediating banks, and challenging the rise of cryptocurrency [12].

While the potential benefits of CBDCs outweigh the risks, it will be important to carefully manage the risks involved in order to realise the full potential of CBDCs. Proper governance and privacy protections will need to be implemented to prevent misuse.

The Road Ahead

While CBDCs still face technological and policy hurdles, their potential is clear. From faster payments to financial inclusion, CBDCs promise to revolutionise finance for the digital age. With thoughtful implementation, central bank digital currencies can usher in the next evolution of money. I intend to follow the development of CBDCs closely because I believe in their economic promise if implemented diligently and collaboratively. CBDCs are an innovation worth pursuing, but to realise their full potential, care must be taken at every step of the way.