When Bitcoin and blockchain came into play, many felt that traditional models and methods of finance could expire overnight, bringing in their place a new dawn of decentralisation.
Fourteen years later, we’re still waiting for this dawn to arrive. But while blockchain
hasn’t followed the same trajectory as the iPhone or, say, Uber, its potential hasn’t
been dismissed by those in charge.
This is evident in the growing interest around Central Bank Digital Currencies, or
CBDCs. As of 2022, more than 100 countries are currently exploring CBDCs, with a
handful looking to run pilot versions in 2023.
But what exactly are CBDCs?
Simply put, a CBDC is the digital form of a country’s fiat currency. It is issued and
regulated by a country’s central bank, and its value is pegged to the fiat
currency of that country.
While similar to the way our money is already digital via online banking, the key difference, much like cryptocurrency, is that CBDCs are purely digital. To use them — again, much like crypto — you will need a specific type of digital wallet that wouldn’t work too dissimilar from how we currently do our online and mobile banking.
Right now there are two different types of CBDCs: wholesale and retail. Wholesale CBDCs work in a similar way to holding reserves in a central bank, although they are not typically used by the general public or businesses, rather institutions. With wholesale CBDCs, central banks will still be able set interest rates and influence lending through monetary policy.
Retail CBDCs, on the other hand, are used by the general public and businesses. There are two types of retail CBDCs: token-based retail CBDCs, which use public/private keys to validate and execute transactions (like crypto), and account-based CBDCs, which require digital identification for access.
While Australia has not yet officially adopted the use of CBDCs, the Reserve Bank of Australia (RBA) has been actively exploring the possibility of issuing a CBDC and has conducted several pilot studies and research projects to understand the benefits and challenges of implementing a CBDC in the country.
The potential benefits and risks of implementing CBDCs
CBDCs present many of the same potential benefits and risks as crypto. On the one hand, they improve financial inclusion by providing easier access to financial services for those who are currently unbanked or underbanked, such as those in rural areas or developing countries.
They could increase efficiency by potentially streamlining payment systems and reducing transaction costs, and they could enhance security by reducing fraud, as digital transactions can be more secure than traditional physical cash transactions.
Lastly, they can increase transparency and traceability in financial transactions, making it easier to detect and prevent money laundering, tax evasion, and other illicit activities.
All of these positive impacts make CBDCs a prospect worth considering, and certainly these are points of difference that governments will focus on promoting if they are to convince their citizens that implementing a CBDC is the right way to move forward.
On the other hand, adverse changes to a country’s financial structure and system, unethical monetary policy influence, issues surrounding privacy, protection, cybersecurity and complex implementation are all factors that must be considered, not just by the government, but also by the public.
The potential benefits and risks of CBDCs will depend on the specific implementation of each country, and the impact of CBDCs will continue to evolve as the technology advances and the use of CBDCs becomes more widespread.
Is the future of finance rooted in CBDCs?
At face value, there is plenty to like about a CBDC. The efficiency and convenience that will likely come with one cannot be understated when it comes to the general public. However, the threat of privacy and security mean it’s a path neither the government nor ourselves should race toward until we have considered every outcome, good and bad.
The RBA has conducted several pilot studies and research projects to understand the benefits and challenges of implementing a CBDC in the country. In 2020, the RBA conducted a proof-of-concept trial to explore the technical feasibility of issuing a CBDC. It was mainly wholesale CBDCs, where the project involved a simulated wholesale payment system that used distributed ledger technology.
While they are keeping the trial close to their chest, it does prove that CBDCs is an evolving field and that cashless is the way of the future. CBDCs will fast track the process by allowing lower transaction costs for sending money along with Eftpos surcharges, could eliminate OSKO or PayID scams and last but not least, give people greater insurance of their holdings as it is a liability of the RBA and not any commercial bank.
It is likely that in advanced economies such as in Australia, wholesale CBDCs are given more focus than retail CBDCs and that will help cross border payments and settle tokenized assets.
But, with the recent collapse of various cryptocurrency exchanges it has given us a snapshot of the worst case scenario when a digital currency fails; if a whole country were to suffer a similar fate it would be an unprecedented catastrophe.
Overall, the implementation of CBDCs will have varying effects from country to country and unless a trial is rolled out, we will not necessarily know what benefits or pitfalls it will bring about with it.