Central Bank Digital Currencies, or CBDCs, have taken center stage as the globe pursues a cashless approach in the aftermath of the Covid-19 outbreak. The CBDC is a digital form of fiat money the country’s central bank creates and may be used as legal currency. Several countries are working on CBDC initiatives all around the world. As a result, throughout this tutorial, we’ll:
- CBDCs are being investigated for their potential.
- CBDC initiatives that are promising all across the world
A/ Design framework of CBDCs
Vox published an excellent piece a while back that highlighted five specific concerns that central banks must consider before establishing a CBDC.
- Should CBDC payments be sent through a central bank account? Should it link the payer and the payee directly?
- Could central banks abandon the use of traditional paper money entirely?
- Shall CBDC like cash and coins, have a fixed nominal value? Should it pay interest or be adjusted to an overall price index?
- What impact will CBDCs have on central banks’ monetary policy in the future?
- What impact does CBDC have on the interactions between central banks and different government agencies?
As a result of these inquiries, Vox came up with the following qualities of a well-designed CBDC:
- It’s a free means of trade.
- Being a safe haven for money.
- The information was made publicly available to the general public.
- Price-wise, it’s rather consistent.
1. What are the benefits of implementing CBDC?
- Depending on where you are, the cost of handling cash might be very different. Countries made up of multiple lonely islands, for example, frequently have an extremely high “cost of currency.”
- The expenses of intermediaries in conventional financial systems might be quite high. With centralized digital money, removing the need for several middlemen is important.
- CBDC has the potential to be a very effective technique of financial inclusion. The truth remains that a huge percentage of the world’s population is unbanked.
- CBDC has the potential to make the global payment system far more robust. A small number of large firms controlling the payment system. Using a DLT-based currency can help tremendously in this situation.
- A well-conducted CBDC, according to the IMF, can fight emerging digital currencies. Digital currencies issued privately can be a regulatory headache.
- The price volatility of cryptocurrencies is one of their most serious issues. Governments can utilize CBDCs to limit price volatility by using a private blockchain.
- CBDCs can allow banks to experiment with Distributed Ledger Technology (DLT), which lead to the growing popularity of blockchain technology (DLT).
2. What are the drawbacks of implementing the CBDC?
While there are certain definite advantages, we must also consider the drawbacks in order to gain a fair perspective:
- CBDCs have the potential to force central banks to charge higher interest rates on loans or endure margin compression. This is due to the possibility that individuals will remove their savings from banks and hang on to their coins. People may switch from bank deposits to CBDCs during times of crisis.
- If the demand for CBDC rises, it will have a significant impact on the balance sheet. In addition, central banks must offer emergency liquidity to local banks facing a big and rapid outflow of cash. As a result, central banks would take on more credit risk.
- CBDCs come with a slew of hidden costs and hazards that central banks should account for. The payments value chain, consumer interfaces, transaction monitoring, and AML and anti-terrorism legislation that activated all central banks.
B/ CBDC solutions
Let’s have a look at some of the CBDC implementations throughout the world now that we have a basic understanding of how they function.
1. SOV – Marshall Islands
SFB Technologies will collaborate with Algorand Blockchain to supply the Marshallese government with blockchain services (SOV). Algorand is an open-source, proof-of-stake blockchain technology that allows developers to create scalable blockchain-native solutions for real-world use cases. SFB Technologies’ co-founder and CTO, Jim Wagner, explains why they chose Algorand as the underlying protocol:
“Algorand was picked as the best protocol option after extensive market research. The firm has already powered multiple major use cases, and its platform has the capability necessary to issue, manage, and distribute the SOV on a worldwide scale because to its unique characteristics. The SOV will be constructed on a scalable and secure platform as a result of our relationship.” To keep inflation under control, the SOV supply will be algorithmically set to expand at a rate of 4% each year.
2. Digital Yuan – China
Pilot testing for the People’s Bank of China’s new digital money, dubbed DC/EP (digital currency/electronic payment), are presently ongoing, according to a spokeswoman for the PBOC on China Central Television. The testing is now taking place in Shenzhen, Suzhou, Xiongan new area, Chengdu, and the prospective Winter Olympics host city.
However, the bank made it clear that the CBDC’s trial testing does not suggest that people would extensively use it in the future. The spokesperson also mentioned the following technological and design qualities of digital money:
- It has a two-layer design and a two-tier delivery method.
- It uses “dual-offline” technology to ensure that transactions are completed even if China’s internet banking and other viability systems are down.
- Ritual payment systems are unavailable due to a lack of network signal strength.
- The DC/EP system is distinct from China’s existing banking system. It is not in any way related to or dependant on the users’ bank accounts.
- Unlike other cryptocurrencies, the People’s Bank of China will issue the Digital Yuan directly (PBOC).
- To maintain price stability, the nation’s credit will back the Digital Yuan.
3. Project Inthanon – Thailand
Project Inthanon, the Bank of Thailand’s CBDC implementation, is now in its third phase. Inthanon is a program in which the central bank and financial institutions collaborate. Its goal is to create and test a proof of concept for CBDC-based domestic wholesale financial transfers. They are currently putting interoperability across ledgers for cross-border financial transfer to the test. To investigate this issue, the bank will work with the Hong Kong Monetary Authority.
Prior to this, the bank successfully evaluated the efficiency of bond trading and repurchasing activities, including interbank outright trading and repurchase transactions. In addition, the bank looked at how distributed ledger technology (DLT) may aid in the banks’ reconciliation of client accounts and money transfers in accordance with rules, reducing error and associated compliance expenses.
4. Argentina’s Central Bank and RSK
The Central Bank of Argentina (BCRA) is now working on a proof-of-concept (PoC) that will give end-to-end account debit claim traceability using RSK technology. The Blockchain Group, which includes IOV Labs, Sabra Group, Banco de la Provincia de Córdoba, BBVA, ICBC, Banco Santander, BYMA, Interbanking, and Red Link, will build the PoC as part of the BCRA’s 2019 Financial Innovation Roundtable.
Rootstock (RSK) is a smart contract platform that uses sidechain technology to connect to the Bitcoin blockchain. The purpose of Rootstock was to make it compatible with Ethereum apps (the web3/EVM/Solidity architecture), but with bitcoin as the underlying cryptocurrency. The purpose of RSK was to provide smart contract capability to the Bitcoin network.
CBDC has the ability to favorably change the global banking sector. CBDCs appears to be a matter of “when” rather than “if” electronic payments replace physical cash-based transactions. There are so many amazing implementations happening all across the world that you should keep an eye on. This is why central banks must work on a solution that gives the greatest amount of value to their respective countries.