The Big Idea: Central Bank Digital Currencies
Throughout the year, we’ll be offering a deeper look at some of the biggest trends we see shaping fintech now and in the coming decade. This week, we’re taking a look at Central Bank Digital Currencies (“CBDCs”). As always, if you have any ideas for us, or there’s anything you’d like to know more about, drop us a note at fintechupdate@gmail.com.
What’s the Big Idea with Central Bank Digital Currencies?
We’ve written a lot about CBDCs recently, reflecting both the increased frequency of CBDC stories and the magnitude of what they could mean to global financial services if they truly take off. At base, a CBDC is simply a digital version of a country’s sovereign currency (e.g., China’s “digital yuan” or the potential U.S. “digital dollar”).
Unlike a cryptocurrency like Bitcoin, which has no central authority, or even a stablecoin like Tether, which is pegged to a sovereign currency, CBDCs are issued by central banks and are therefore backed by the full faith and credit of a national government. Indeed, CBDCs are a peculiar breed of digital token – one that in many ways runs opposite to the goals of decentralized tokens like Bitcoin, which were born as alternatives to centralized, highly monitored, government-regulated currencies.
In fact, central banks’ nascent efforts to develop digital versions of their currencies may be largely motivated by creating such alternatives. As evidenced by their strong pushback against private token initiatives like Libra, central banks around the world have a keen interest in maintaining control and oversight over money movement involving their currencies and–especially—their citizens. CBDCs are one way that central banks can continue to control access to and use of the primary means of payment in a world where cash usage declines every year and more people prize digital-first tools, ease of access to their funds, and reduced barriers to money transmission and exchange. More conceptually, CBDCs may offer new ways to implement monetary policy.
Why should we care?
We should care because a country that invents the future also takes a strong hold of it. If you’ve been following the digital currency space with any level of interest recently you will have seen the CBDCs are all the rage – particularly in China. Depending on what you’ve read, China has simply become the first country to successfully pilot a CBDC (sorry, Bahamas); or, more grandly, has shifted the entire calculus of great power competition by leaping to an unassailable lead in the race to digitize currencies. We don’t care to take part in that particular debate, but it is certainly true that most of the coverage around CBDCs to this point has been in reference to China – such as its recent launch in two major cities, or its subsequent crackdown on Tether and new law banning non-yuan stablecoins – because it is the only major international player with a live CBDC.
But, while China is busy inventing its CBDC future, other countries and transnational institutions have largely been content to consider, research, and write papers. The International Monetary Fund, for example, recently produced a research paper [full text], arguing that CBDCs could displace domestic currencies and boost illicit capital flows; and the Bank of International Settlements published a report [full text] “identifying the foundational principles” for CBDCs while declining to take a position on them. Meanwhile, U.S. Federal Reserve Chairman Jerome Powell has said that a U.S. CBDC could drive benefits for consumers and businesses; the Bank of England plans to conduct ongoing research into CBDCs; and the Swedish central bank is making progress with testing the technology that could support an “e-krona”... but none of these announcements have come with clear commitments or technical plans.
So, while we’re neither convinced of the importance of CBDCs nor that China has an insurmountable lead when it comes to them, we’re not dismissing it, either.
What to Watch For
If you don’t live in mainland China, CBDCs won’t be something that impacts your life for at least several years—if ever. However, from a public policy point of view, the debate about CBDCs is coming, and you should start paying attention. Are CBDCs a net positive over traditional currencies, or are the old systems best? Would they increase financial inclusion, or would they be a faster, more digital means of facilitating financial inequality? Would the improved transferability of a digital currency allow for faster cross-border payments or simply a faster vector for fraud? Would CBDCs improve or destroy individuals’ financial privacy, and would the benefits of the latter (stemming global money laundering) outweigh the downsides (uh, no privacy?)?
These are big, knotty questions, and we need citizens, regulators, and financial professionals to properly understand them in order to come up with the right answers. Some countries are already running toward these answers, while others are taking baby steps. We’re a long way from knowing who will win, but one thing is for certain: the race has already begun.