* From research to reality: 100 nations explore CBDCs, setting the stage for a digital financial future
Digital currency has the potential to completely change the way a society thinks about money. Thousands of currencies (BTC, ETH) exist in electronic form that have led central banks to ponder over how they might work. Most countries’ financial system is already dominated by electronic form of currencies and not digital currencies, physical form being the sole difference between the two. A digital currency can only be exchanged through digital means unlike an ATM which stores the records electronically but dispenses cash in physical form. There are three main types of digital currency:
- Cryptocurrency
- Stablecoins
- Central Bank Digital Currency (CBDC)
Cryptocurrency
Crypto, as it is called in short, eliminates the role of traditional intermediaries like central banks or governments and is only exchanged through networks between transacting parties via a decentralised system. Records are maintained and secured over a digital ledger (Distributed Ledger Technology-DLT) or Blockchain for creation and transfer of coins.
In practice, they are a distinct asset class that can be collateralized against the amount of stake. The first cryptocurrency was Bitcoin which was first released in 2009. As of March 2022, there are 9,000 cryptocurrencies in the market of which more than 70 have a market capitalization of USD 1 billion.
Stablecoin
It is a cryptocurrency where the value of the digital asset is pegged to a reference asset which could be a commodity, fiat money or another cryptocurrency. Theoretically, backing by a reference asset will cause the value of stablecoin to depend on the value of the peg and not market changes which is why they have got their name. In practice, they are non-interest bearing and are less volatile than cryptocurrencies.
CBDC
A CBDC is issued by a central bank backed by the government. It is analogous to a digital form of paper money (digital banknote) as it will not replace cash. In present scenario, the best use of digital currency is to make online payments for P2P (Person to Person) or P2G (Person to Government) purpose.
Since central banks enjoy the sole authority of money creation and supply which they do keeping in view the real sector growth and inflation trends, hence the prospects of its acceptability among masses is greater as compared to the above two.
To sum up, following are the key differences between digital currencies and cryptocurrencies:
| Digital currency | Cryptocurrency |
|---|---|
| Centralised | Mostly decentralised |
| Exists online | Recorded on a block chain database |
| Treated as money or income | Treated as property |
| Not transparent | Transparent |
| Regulated by central banks | Regulated by private sector |
| Fall under legal framework | Official status is not defined |
| Stable | Volatile |
Blockchain
Blockchain is a type of a distributed ledger. Distributed ledgers use independent computers or nodes to record, share and synchronize transactions in electronic ledgers instead of traditional ledgers. The data is organized in form of blocks which is then appended in a chain.
Blockchain is the building block for ‘’internet of value’’ and enable recording of interactions (identity and personal information) and transfers (security, money and land titles) on a decentralized ledger. In this way, DLT has the potential to not only change the financial sector but it could also revolutionize manufacturing, energy and aviation industry. It could help to reduce remittance costs and could bring marginalized population within the folds of financial inclusion.
| Advantages of digital currency | Disadvantages of digital currency |
|---|---|
| Faster payments | Too many options |
| Cheaper international transfers | Steep learning curve |
| 24/7 access | Expensive transactions |
| Support for the unbanked | Price volatility |
| More efficient government payments | Slow progress |
Bank of England’s Digital Pound or ‘Britcoin’
The UK version of CBDC i.e. digital pound would be a new type of money issued by the Bank of England (BoE) for everyone to use for day-to-day spending and online payments. It may also be called digital sterling or Britcoin.
The digital pound would be denominated in sterling and its value will be stable. A 10-pound digital sterling would always have the same value as a 10-pound banknote. If introduced, it will not replace cash as being able to use cash is important for many people. That is why the bank will continue to issue it for as long as people want to keep using it.
Opportunities
There are a number of ways in which CBDC could support the BoE’s objectives to maintain monetary and financial stability through the provision of a new form of money and a new payments infrastructure. These are summarized below:
- Supporting a resilient payments landscape
- Avoiding the risks of new forms of private money creation
- Supporting competition, efficiency and innovation in payments
- Meeting future payments needs in a digital economy
- Improving the availability and usability of central bank money
- Addressing the consequences of a decline in cash
- As a building block for better delivery of cross border payments
Objectives and design principle
- CBDC payment system need to be designed with clear user use cases encompassing all areas – payments for households, small businesses, wholesale clients and cross border payments.
- Setting up of a resilient, inclusive, innovative and competitive payment system for fast, efficient and reliable payments by individuals and SMEs sets the tone for design principles of CBDC
- Private sector needs to be on-boarded by central banks to address the competition angle of the design principles
Conclusion
Since people are willing to adapt to digital currencies and technology is ready to accept operational challenges, it all depends on the regulatory framework designed by central banks which could lead to smooth transition without creating any chaos.
A prudently designed CBDC could address the volatilities of unregulated crypto currencies and could potentially offer more resilience and safety, greater availability and lower costs.
At present, there are some 100 countries that are researching and testing CBDCs while some have even started distributing it to the public. It is pertinent to mention that central banks around the world need to see themselves as enablers or promoters of digital currencies. Enactment and enforcement of regulations is one thing but they also need to proactively engage with all stakeholders including private sector. Only then could the vision of financial inclusion be fulfilled in a rapidly evolving digital space.