Central Bank Digital Currency (CBDC) is a new form of money that exists only in digital form, issued by a state’s central bank. It is different from virtual currencies and cryptocurrencies since it is backed by a state’s authority. Most central banks worldwide are now in various stages of their evaluation of launching their national digital currencies. As of January 2023, five central banks have already launched their CBDCs. CBDCs offer several advantages over traditional payment systems, including technological efficiency, financial inclusion, proof of transactions, and combating crime, among others. However, it also poses some risks such as banking system disintermediation, digital exclusion, and cybersecurity.
One of the advantages of CBDCs is technological efficiency. CBDCs eliminate intermediaries such as banks and clearing houses, enabling real-time money transfers and payments from the payer to the payee. This feature reduces the risk of payment delays, as payment verification is instantaneous, and eliminates the need for intermediaries to handle the risk of payments not succeeding. It also reduces the complexity of transaction tracking since merchants do not need to keep track of slow transactions separately. CBDCs also have the potential to reduce or eliminate transaction fees associated with payment systems such as Visa and Mastercard, leading to widespread price drops and increased adoption of digital payments.
Another advantage of CBDCs is financial inclusion. Safe money accounts at the central banks could provide a strong instrument of financial inclusion, allowing any legal resident or citizen to have access to a free or low-cost basic bank account. This feature would enable individuals without a bank account to participate in the financial system, reducing financial exclusion.
CBDCs also help prevent illicit activity by enabling the central bank to keep track of every unit of currency. This feature makes it difficult to engage in tax avoidance and tax evasion since financial activity cannot be hidden from the central bank or government. CBDCs also make it easier to spot criminal activity by observing financial activity, making it easier to put an end to such activities. In cases where criminal activity has already occurred, CBDCs make it harder to launder money, and it would often be straightforward to instantly reverse a transaction and return money to the victim of the crime.
CBDCs provide a digital record of transactions, proving that money changed hands between two parties. This feature avoids problems inherent in cash, such as short-changing, cash theft, and conflicting testimonies. CBDCs also provide a modern alternative to physical cash, protecting money as a public utility.
Moreover, CBDCs provide a secure and standard interoperable digital payment instrument issued and governed by a central bank, increasing confidence in privately controlled money systems and boosting competition in payment systems. CBDCs also preserve seigniorage income, avoiding a predictable reduction of seigniorage income for governments if physical cash disappears.
CBDCs offer an alternative to fractional reserve banking for daily use, which is safer for those who want to avoid all risk of bank runs, despite the relative safety provided by deposit insurance. CBDCs also have the potential to provide a new channel for monetary policy transmission, allowing more direct control of the money supply than indirect tools such as quantitative easing and interest rates. CBDCs could encourage spending and discourage money from sitting in a savings account, boosting the economy.
However, CBDCs also pose some risks. One concern is the disintermediation of the banking system. With the ability to provide digital currency directly to citizens, depositors could shift out of the banking system, reducing the role of banks in the economy. This could lead to economic instability, and central banks must ensure that the banking system remains viable.
Another concern is digital exclusion. Although CBDCs offer financial inclusion to those without bank accounts, those without access to digital technology may be excluded. Central banks must ensure that value of the currency or by implementing demurrage. Demurrage is the practice of reducing the value of money over time, which incentivizes spending and discourages saving.
Another risk associated with CBDCs is the potential for cyber attacks. As digital currencies are entirely digital, they are vulnerable to cyber attacks. The loss of user data or access to digital wallets could result in significant financial losses for individuals and businesses. Additionally, the use of CBDCs could make it easier for hackers to carry out financial crimes such as money laundering and terrorist financing.
Finally, the implementation of CBDCs could have unintended consequences on the overall financial system. For example, if CBDCs result in the disintermediation of banks, it could reduce the availability of credit, which could slow economic growth. Additionally, if CBDCs result in a shift away from traditional forms of money, it could make it more difficult for central banks to implement monetary policy.
In conclusion, CBDCs have the potential to revolutionize the way we think about money and payments. By reducing the need for intermediaries and increasing financial inclusion, CBDCs could make payments faster, cheaper, and more secure. However, there are also risks associated with CBDCs, including the potential for cyber attacks, unintended consequences on the financial system, and the risk of disintermediating banks. As central banks around the world continue to evaluate the potential benefits and risks of CBDCs, it is important to carefully consider the implications of this new form of digital currency.
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