Central Bank Digital Currencies (CBDCs) are gaining global attention. Governments are exploring the potential of these innovative digital currencies, looking to modernize their economies with government control. Some countries, such as Jamaica and China, are already well into their development, with China the most advanced with the digital yuan. This article highlights the biggest pros and cons of CBDCs, taking a look at what the opportunities CBDCs hold but also the challenges they present to consumers, banks and businesses.
What are central bank digital currencies?
Central Bank Digital Currencies are a new form of money that is issued digitally by a central bank. These government-backed digital currencies use the blockchain to issue digital coins instead of physical cash.
The COVID-19 pandemic marked a big shift in interest in CBDCs. Payment habits became more digital, and more and more people began to understand both the mechanisms and benefits of digital payment systems. In the UK, for instance, the Bank of England released a study that showed only 23% of total payments made were in cash in 2019, a decline from 60% a decade previously, and this dropped even further to 17% in 2020. By 2021, that was 15%. Whilst the decline in cash usage slowed once the pandemic faded, it is a trend that looks set to stay, and is reflected globally.
Pros
Security. CBDCs are more secure for users, reducing criminal activity. Financial fraud and tax evasion can be avoided with the introduction of digital wallets allowing central banks to collect identification information and track criminal transactions. The transparency inherent in blockchain technology offers strong encryption and a transparent record of all transactions.
Financial inclusion. CBDCs can be utilized to reduce dependency on cash. Cash is expensive to handle, so communities with poor access to physical banks find transacting, storing, and processing cash difficult. Physical banking infrastructure is reducing across the world, but without something to replace it such as digital currencies that people are financially literate in, people are being more financially excluded from the economy. Romania frequently tops the charts as the country most dependent on cash, with almost 80% of payments annually being handled in cash. Kazakhstan, Egypt, and Ukraine typically join them on the list.
Digital currencies can be used by anyone who uses an electronic device. Globally, almost 90% of phones used are smartphones, and there are over 7.2 billion of them in the world, with the number always increasing. Financial accessibility to CBDCs does not require physical infrastructure, new technology, or expensive upgrades. This is true of all digital assets, such as crypto or NFTs. Still, being government-backed, it adds an extra layer of stability and inclusion to the existing financial system, which is vital for unbanked and underbanked individuals.
Cost and efficiency. As we mentioned before, digital currencies don’t require physical infrastructure. CBDCs don’t need to be processed by people, in bank branches, as physical entities. CBDCs also drastically reduce transaction fees and simplify the process, cutting out the need for intermediaries - further reducing costs.
Cons
Cross-border transactions. There are significant challenges to coordinating CBDCs across different countries. Countries will need to work together to create structures and payment schemes that allow cross-border transactions. However, pilot programs are underway in regions where CBDCs are being implemented, with a strong focus on digital wallets that can adhere to compliance requirements across different jurisdictions. Project mBridge is a collaboration between Hong Kong, Thailand, and the United Arab Emirates - and recently Saudi Arabia - to work across borders on a blockchain-based payment platform.
Stability and security. If there is a sudden surge in demand for CBDCs, it could cause a run on banks and destabilize the financial system. Digital currencies can also be vulnerable to cyberattacks, which raise concerns about privacy and security. To counter this, central banks will have to invest a significant amount of money into security infrastructure development.
With the reduced need for physical bank branches and humans handling cash, jobs will be lost if the system changes to a stronger dependency on CBDCs. That’s true of any digital currencies, such as stablecoins, or digital wallets that have become increasingly popular across the world. With central banks becoming the holder of individuals’ money, this could lead to less going into licensed institutions.
Loss of data privacy and increased surveillance. This criticism often comes from those familiar with crypto and blockchain users. Digital currencies backed by the government do not have the same anonymity and privacy from officials as regular crypto transactions or holdings. There are concerns that with government involvement, CBDCs can be abused by government control and centralization.
