Central bank digital currencies (CBDC) have been a talking point for many years since the boom of private e-currencies. A few countries have been tentatively testing the currencies, which more recently have started reaching fruition.
But what is a CBDC?
CBDCs are a digital form of fiat money. Taking a step back, it is worth recapping on what fiat money is. The term refers to a currency that is not backed by a physical commodity, e.g. gold, and instead is backed by the government or authorising body that issues the currency. As such, fiat money is inconvertible legal tender. For those of us that have not studied Latin, the word “fiat” is translated as “let it be done.”
So, for example, a US and British CBDC could be explained as an e-USD and e-GBP respectively.
Why is the idea being considered by central banks?
- Despite remaining a popular form of payment, cash use in some countries has been in decline. Some countries and even regions are also clearly looking to transition to become cashless societies, such as those in the Nordics and South Korea. As other forms of electronic-based payments gain more traction and rise in popularity, such as payment cards, contactless payments, app payments, account-to-account payments, etc., people are naturally moving away from cash payments. A CBDC, therefore, seems a logical step towards supporting the trend towards cashless payments as consumers and businesses will have access to legal tender even if the amount of cash in circulation decreases
- A paper-based fiat economy also involves numerous costs. It costs to print and circulate paper-based tender. The move towards CBDCs could lower the cost of managing the whole process, as the associated costs involved with printing and minting money will be removed
- A central bank managed digital currency could help lower the risk of tax avoidance and money laundering. Digital currency is generally more secure and much easier to trace than cash payments, which is especially important for high value and large volume transactions
- Faster, around the clock payments can be achieved by circumventing intermediaries, meaning payments could be made in real-time between parties faster and with much less friction
- Digital currency could also help simplify and streamline cross border payments. By its nature, a digital currency will help overcome two of the enduring challenges faced when making cross-boarder payments, that of payment transparency and traceability. This is of course in addition to reducing the costs associated with making cross border payments
- Enhanced money flow management and reducing the risk of bank runs are two other benefits a CBDC offers. A bank run is when many different clients of the bank request to withdraw money at the same time. As the bank only has a finite amount of physical assets stored, this will result in the bank having a weaker funding position. Through removing the physical asset element, central banks will be in a better position to control the flow of money and increase the quantity of currency in circulation if necessary, making bank runs less of an issue
Where are these digital currencies being developed?
Many countries have been trialling the idea in different shapes and forms with varying degrees of success.
- February 2015 – Ecuador introduced a digital currency to run in parallel with its cash system. Their goal was to help the battle against poverty by decreasing the cost of printing physical currency. The currency failed to meet the government’s expectations as it passed legislation to abolish the CBDC in December 2017. It was fully deactivated March 31st, 2018
- December 2016 – West Africa’s Banque Régionale de Marchés released the eCFA in Senegal as a trial for a central bank currency in the area. This had the possibility of improving banking access for the millions of unbanked Africans, with a digital currency that works across all digital platforms. The long-term goal for the eCFA was to release the currency to the wider Francophone countries in West Africa
- February 2018 – Venezuela releases the controversial, government-backed Petro. The cryptocurrency was designed to be based on oil and mineral values of the country to try and offset the financial crisis the country was facing. Due to the lack of trust in the government, the currency did not thrive and disappeared by August 2018
- March 2019 – The Eastern Caribbean Central Bank (ECCB) in partnership with Bitt Inc., a Barbados based fintech dedicated to blockchain and distributed ledger technology, launched a digital currency. The main goals of the currency were to improve simplicity between cross border payments in the Caribbean, decrease cash usage, promote better financial stability and expedite growth. The trial for the digital currency began in 2019 and predicted to be fully rolled out by 2021
- December 2019 – News broke that the ECB was considering setting up a task force to make strides towards developing its own digital currency. The ECB’s interest and appetite for CBDC do not appear to be shared by the European Council and Commission who are more pessimistic, wanting to see legal, regulatory and oversight challenges and risks adequately identified and addressed before any development takes place
- February 2020 – The most recent contender on the digital currency front is Sweden’s e-Krona. The Swedish bank is currently piloting the e-Krona and will continue to do so until 2021. The pilot will test the viability and impact of the digital currency in light of the dwindling cash use in the country. If the rate of cash use continues to drop as it currently is in Sweden, there are worries that it will be unprofitable for businesses to accept cash, meaning a CBDC would be necessary for their economy
What the future looks like
Although the path for digital currencies has been rocky in the past, the above examples of CBDC represent the potential they provide as well as the potential barriers to wider success.
We expect countries that have publicly detailed plans to move to a cashless to be at the forefront of CBDC roll out and adoption. China, in particular, seems to be very optimistic about an e-Yuan while South Korea is quickly moving towards a cashless society. Nevertheless, optimism and the drive to transition to a cashless society is not shared across the region.
A lot of work and testing still needs to be done, but encouragingly, more recent CBDCs seem to be having more and more success, but with a lack of clear winning case studies, cash will be around for some time.