Are CBDCs the future of monetary systems?

The world is becoming more and more digital as time passes, with finance services championing this transformation, especially with the increasing demand of contactless digital payments swooping in, as the global Covid-19 pandemic magnifies our need for them.

Many central banks around the world are looking to create their own digital currencies (CBDC) to spearhead the changing tides of the financial world.

The initial debate over this topic was sparked when social networking titan Facebook announced that they would be launching their very own Libra cryptocurrency last year.

As many have mistaken CBDCs for cryptocurrencies, they are fundamentally two different things.

According to U.S.-based think tank, Brookings Institution, CBDCs are traditional money, but in digital form; issued and governed by a country’s central bank. By contrast, cryptocurrencies like bitcoin are produced by solving complex math puzzles and governed by disparate online communities instead of a centralized body.

What’s common between both digital currencies, to a varying degree, is that both of them are reliant and based on blockchain technology; blockchain is a distributed ledger technology (DLT) that allows information to be stored globally on thousands of servers.

When two companies are in business together and use cryptocurrency as payment, the agreement forms the “block” in the chain. However, while some brick-and-mortar stores and many businesses do accept Bitcoin as a form of payment, cryptocurrencies are not considered to be legal – CBDCs, on the other hand, would be.

“Unlike central bank money, both traditional and digital, the value of cryptocurrencies is determined entirely by the market, and not influenced by factors such as monetary policy or trade surpluses,” the report by Brookings highlighted.

According to the Bank of International Settlements (BIS), electronic cash is more often than not held and supported by banks or on pre-paid cards paid for in hard currency to represent the numbers on a screen.

In this case, however, CBDCs act as a complete replacement for bank notes and coins all together, shedding away its representation in physical funds.

Many central banks around the world view CBDCs as a more cost-effective and efficient replacement for the traditional payment systems that have been around for decades, in the hopes of reducing transfer and settlement times, which would subsequently spur economic growth on a massive scale.

In parallel, CBDCs are seen as the natural champion that would face off against the rise of private sector issued cryptocurrencies such as Facebook’s Libra.

The fear among central bankers is not targeted toward the highly volatile and inconsistent state of cryptocurrencies, but mainly deals with the private sector’s effect on the financial system that would quickly erode sovereignty over monetary policies.

Many consider that CBDCs could address problems like inefficient payments that cryptocurrencies seek to solve, while maintaining state control over money.

The beauty of CBDCs is their ability to fully digitize the entire monetary system, allowing it to become more efficient with easier access to funds all while being transparent, due to the use of blockchain technology.

The theory goes that due to the CBDCs being centrally controlled, regulated, and backed by local governments, then it would grant them legitimacy, trust, and stability in the eyes of citizens and consumers.

This would also pave the way for better monetary policies to be enacted, allowing them to flow more directly and seamlessly while not being hampered by third parties, which would fuel cashless economies and systems.

CBDCs would allow citizens direct access to their funds via the central bank, or via commercial bank partnerships which would subsequently explode financial inclusion to another level; this is a radical change to the financial system, as people would enjoy secure access to their money merely through a smartphone and an Internet connection.

As the notion of CBDCs is still in its infancy, African countries such as Ghana and Rwanda are spearheading research and investigation into the potential use and investment into digital currencies in an attempt to provide financial support to its huge unbanked population.

While most countries are still in the research stages, France has already piloted a CBDC transaction, and Sweden is currently carrying out a one-year trial of the new e-krona, built on the Corda DLT platform.

Be that as it may, central bank digital currencies still need years of development to reach the mainstream, but the sooner banks and financial services can anticipate and prepare for the move, the sooner a seamless transition can be made.

However, one need not forget the barriers that come along with any digital transformation, from policy and regulations to the greater risk of cybersecurity.

If the central banks of the world are able to quickly adapt to the changing tides and fully support this transition, then humanity would be heading toward a new dawn of a more democratized monetary system all together.