Today we are in amidst of a technological revolution, the rise of distributed ledger technology offers a novel approach to recording ownership of assets that has allowed for the creation of new financial products such as Central Bank Digital Currencies (CBDCs). More than 60 Central Banks have been exploring CBDCs since 2014 with China’s Digital Currency Electronic Payment (DCEP) being the dominating project with over 70 million transactions worth US $5.3 billion, and even Sweden is in a pilot-testing phase for e-Krona, which they are planning to launch by 2026.
The US is proactively researching CBDCs and is set to launch a discussion paper tackling the public policy issues surrounding a CBDC. While this multi-year long research is expected soon, the Federal officials appear divided on the need for a CBDC.
At a time when other large economies, such as China, are moving aggressively, the officials within the Federal government are skeptical whether the benefits will outweigh the costs or not; and it doesn’t help that there are various political minefields surrounding the issue.
Talking more of the cost and benefit analysis, CBDCs are promised as reliable, sovereign-backed alternatives to private currencies which are volatile and unregulated. The key drivers leading to greater adoption of digital currencies can be attributed to their efficiency, low-cost instant payment, financial inclusion, prevention of corrupt and illicit activities, reduced end-user costs and contribution to meeting the sustainability agenda. Smart contracts enabled by programmable algorithms will make currency a digital asset which is secure, transparent, and immutable. Through digital currency, it’s estimated that the Central Banks could save up to 90% of the costs involved with transporting, storing, and replacing damaged physical currency, this can lead to greater profits for the government.
While the market trend is towards an increased adoption of digital currencies, it is imprudent to not consider the potential risks to the users and broader financial systems. Along with cannibalization of cash, CBDCs raise some concerns around data privacy and security that can’t be overlooked: a system where all data is stored in a central location creates one point of failure, leading to concerns around potential data breaches. CBDCs provide governments the ability to collect incredible amounts of information about consumers, which could potentially be shared with other entities, further accentuating threats to privacy. Additionally, some consumers may be uncomfortable with the added level of surveillance. Some mandates have been put in place, which regulate and protect consumer privacy and their rights, such as the California Consumer Privacy Act (2018) and EU’s General Data Protection Regulation (GDPR, 2018). However, some of the questions remain unanswered:
Who will be custodian of the data?
Who will be held responsible for breach of security?
Who will regulate the laws governing the data breaches?
While maintaining the liquidity pressure, meeting anti-money laundering guidelines, and securing data privacy requirements, banks will need to adapt to the ever-changing landscape. Additionally, a shift from bank deposits to CBDCs will shrink the banks’ balance sheets; this in turn may lead to a decrease in their lending.
Evaluating the vague nature of possibilities that arise from digital fiat currency, Central Banks across the globe are facing a growing need to develop a digitally backed secure currency due to the increasing importance given to cryptocurrencies. However, for certain countries like the US, there may be other priorities concerning their financial systems, and the argument of opponents that a CBDC may erode individual privacy proves that we are still at a crossroads regarding the decision to give a greenlight to CBDCs.