You must have heard of Central Bank Digital Currencies in the crypto market as it has become quite popular lately. Central Bank digital currency is considered to be one of the most significant inventions in the evolution of money. CBDCs are just everywhere, from mainstream media to inside the debates of policymakers, and no one has stopped talking about them since they were first introduced to the world.
Central Bank digital currency is indeed becoming a massive hit and collecting praise from people around the globe, yet there are a few constraints that everyone should look into to understand the role of central bank digital currencies in the future of money before drawing any conclusion. Money is indeed evolving rapidly, and heading towards Central Bank digital currency can prove to be effective in the current situation.
Here, we are going to look more into CBDCs and the role of this currency in the future of money by considering various aspects related to the same. Before moving further, let’s get to know about Central Bank digital currency in detail.
What is Central Bank Digital Currency?
The involvement of CBDCs in the current market is revolutionary and has the potential to change the payment pattern. CBDCs have a lot of benefits, but this digital currency brings along multiple risks as well.
CBDCs are digital tokens issued by the central bank in the form of legal tender. The monetary value of these tokens will be equal to the country’s physical fiat money value and can be exchanged one-to-one with similar fiat money. Central bank digital currencies can easily be stored in digital wallets that users can even keep on their mobile phones.
Yes, Central Bank digital currency is similar to ‘crypto’, but it offers the most important features which are lacking in other popular crypto tokens, and the support of central banks is one such reason.
The holding of these CBDCs requires high technology, which will be provided by the concerned government to help people keep their money in the form of CBDCs. Undoubtedly, Central Bank digital currency has the potential to replace physical banknotes. Also, CBDCs can be a good substitute for ‘crypto’ because popular digital tokens are developed by private developers and do not have a legal tender that can potentially bring monetary risks. Still, CBDCs are backed by central banks and can help you in case of any money-related issues.
Let’s have a look at the differences between digitized cash in your bank account and CBDCs.
Difference Between CBDCs and Digitized Cash in Bank
One of the most significant differences between Central Bank digital currency and digitized cash in banks is in terms of “liability ownership”.
Your assets or the money you deposit into your bank account becomes the liability of the bank. The money you deposited into your bank account is now owed to you by the bank. Now, the bank is liable to repay the amount immediately if you request it.
However, as we talk about the liability of CBDC, it is not owed to you by the commercial bank but by the central bank. Since only central banks commonly have the authority to issue money, CBDC proves to be a more secure form of asset for holders.
Purpose of CBDC
The primary purpose of a CBDC is generally to offer a safe and convenient form of digital money to businesses and users, which is easily accessible as well.
The purposes of CBDC can be further categorized as follows:
Offer easy access to the public to a type of digital money that does not involve liquidity risk and credit.
Credit risk refers to someone’s inability to repay you the money. There is a correlation between liquidity and credit risk. In the case of a bank, it might be able to return the deposits to you; however, they are not capable enough to do it all at once.
The “bank of banks” in a particular nation, often known as the central bank, is thought to be liable for CBDCs, which are possibly the most secure type of banks in the domestic financial system of the nation. Since the central bank is primarily responsible for issuing currency, there should not be any liquidity risk or credit involved.
Establish a safe and practical system of digital payment for both businesses and clients.
The establishment of a structure that can safeguard the confidentiality and confirm the identity of people who are involved in conducting transactions using CBDC is a crucial component of CBDC development. Moreover, CBDCs are supposed to be capable of managing massive volumes of transactions made at both domestic and international levels.
Encourage financial inclusion
It is common to find people who are not able to afford even the most basic financial services. This includes maintaining a bank account. These people are known as the “unbanked”.
However, with the help of CBDCs, the unbanked can easily access the various forms of banking services; this is one of the major advantages of creating digital money discovered by the Federal Reserve.
Maintain or strengthen the value of a currency in the world economy
Picture being the sole country in the world without a CBDC. While everyone is utilizing their digital currencies to transact with one another, you are still in the “old world” of digitizing paper money to purchase or sell items globally.
The old method is significantly slow, which becomes the primary distinction. In this scenario, you can be the lagged nation in the global economy. It is quite essential to have a CBDC system to maintain pace with the global economy. This could be a more concerning situation than it might seem to be. In any case, it would be right to motivate nations to make efforts toward CBDC development.
Preserve economic stability and regulate economic growth by assisting the central bank
The responsibility of a central bank is to oversee and direct the monetary system of a nation. It must maintain the majority of its workforce employed, stabilize its national currency, and address inflation if necessary.
However, the actions of a central bank can have a limited impact only. The decisions made by the central bank does not impact the economy immediately; there is a delay in between. There is a lot of money moving into the system.
CBDCs as the Future of Money
The discussion around the CBDCs is going to increase in recent times with the upgrade in technology, and it will have multiple consequences as well. The reason is CBDCs are not yet completely ready to be rolled out by any government immediately.
Let’s get to know about some important advantages and disadvantages of CBDCs to understand the future of money.
Advantages of CBDCs
The buzz for Central Bank digital currency in India is due to the legality of its transactions and the benefits associated with these digital tokens. CBDCs can prove to be effective in terms of cost as compared to physical money. The cost of transferring and managing cash can be direct if the government chooses to make transactions in the form of Central Bank digital currency.
CBDCs can also help enhance financial inclusion for all components of the economy. This digital technology will allow every legal person to open a low-cost bank account with the central bank. In this process, the motive of the central bank should be to keep the money of every individual safe.
It gets quite difficult to track crimes that involve cash transactions; however, it can be solved with the help of Central Bank digital currency. CBDCs will make it simple for the Central bank to trace every part of this currency which can benefit the government in fighting against tax evasion and financial crime.
Disadvantages of CBDCs
Similar to other technologies, CBDCs also have some significant disadvantages which can not be ignored at any cost. One of the most crucial risks invoked in CBDCs is related to other financial banks in the country. For instance, if the people of the country start drawing out all their money from their bank accounts to invest in CBDCs, it will adversely affect the financial position of the banks.
The second issue is concerned with the data privacy of the individual. For centralizing digital currencies central, you will have to provide your details to the government.
Lastly, the legal system of our country is not modernized or comprehensive enough to evaluate the transactions concerned with new forms of money. In the absence of an efficient legal system, making transactions in the form of Central Bank digital currency can be financially risky for the banks.
Even after these considerations, multiple economies around the globe are so keen to kick-start central bank digital currencies as soon as possible.
This is the future of money that we can see with the introduction of CBDCs:
- It’s quite probable that the future of money will be a mix of centralized, decentralized, token or account-based CBDCs, stablecoins, and cryptocurrency, along with the traditional physical and digital currency.
- Central bank digital currency will affect the deposit and loans section a lot; more people will take out their money from their bank accounts to invest in CBDCs, this will result in higher asset management costs with fewer investments, and they will be forced to set higher interest rates on deposits.
- CBDCs have the potential to disrupt the payment system in the central framework. The private CBDCs companies will have highly efficient technology to make higher-value payments instantly with the central institutions. It will pose a threat to financial institutions and will emerge as one of the best options for making payments.
- ATMs and Bank branches are already on the verge of extinction, and very few individuals currently use them. With the effective introduction of CBDCs, the use of ATMs and banks will significantly decline.
The success of CBDCs can be seen as multiple countries are testing the use of this digital currency around the globe. Central Bank digital currency in India can also work well if the government creates a good system to deal with the negative aspects.
The Government of India has already disclosed its views on cryptocurrency and declared it as an asset but not legal tender as it is not backed by RBI or the union government. In this case, the introduction of CBDCs can bring a revolutionary change in the whole economy.
The above-mentioned sections suggest the role of Central Bank digital currency in the future of money and how it has the potential to be one of the best options in the world of digital currency.
FAQs on Central Bank Digital Currencies
How does a CBDC differ from cryptocurrencies like Bitcoin?
CBDCs are regarded as a form of fiat currency because they are issued and backed by the central bank, in contrast to cryptocurrencies like Bitcoin. Because CBDC transactions can be tracked and monitored by the central bank, they are less anonymous than cryptocurrencies.
How is a CBDC different from digital payments and e-money?
CBDCs are a type of digital fiat currency that is issued and backed by a central bank as opposed to digital payments and e-money, which are typically issued by private entities. This makes them distinct from digital payments and e-money.
How will a CBDC impact the traditional banking system?
A CBDC’s effect on the conventional banking system will depend on how it is set up and operated. While some experts think a CBDC could disintermediate banks, others think it could strengthen financial inclusion and complement the current banking system.
Which countries are exploring or developing CBDCs?
Previously China, Sweden, the European Union, the United States, Japan, and the United Kingdom are just a few of the nations that are investigating or developing CBDCs. 2023 already has the makings of being a significant year for central bank digital currency (CBDC) research.
64 nations were in an advanced stage of development as of March 2023, and more than 20 central banks, including those in India, Brazil, Japan, and Russia, had started their pilot programs.