What are CBDCs and Why Should You Care?

CBDCs is an abbreviation for Central Bank Digital Currencies.

These, simply put, are a form of digital currency issued by a country’s central bank, rather than by a commercial bank. They have some similarities to cryptocurrencies, however, their value is fixed by the central bank and equivalent to the country’s fiat currency.
(If we would simplify that, imagine a stablecoin backed by a country's fiat currency)

First CBDC

The concept of central bank digital currencies (CBDCs) is not new. Some consider as the first CBDC, the Avant smart card that was issued by the Bank of Finland in 1993.

The CBDCs gained more attention after the rise of cryptocurrency and the first nationwide CBDC was launched by The Bahamas in October 2020. That digital currency is known as the Sand Dollar and its aim is to improve financial inclusion, reduce service delivery costs, and increase transactional efficiency.

Many central banks are exploring the possibility of using CBDCs to provide businesses and consumers with privacy, transferability, convenience, accessibility, and financial security.

Different types of CBDCs

There are different types of CBDCs, depending on their design and purpose.
Retail CBDCs would be the digital form of banknotes that everyone could use to make payments or transactions. Wholesale CBDCs would be available to financial intermediaries and operate similarly to central bank reserves offering some additional features. Would/Will CBDCs use distributed ledger technology (DLT)? There is not a definite response to that yet.

What are the challenges & risks?

There are different and significant challenges & risks regarding CBDCs, both for central banks and for society. There may be implications for financial stability and data privacy queries. CBDCs could affect the role of commercial banks and this could bring unwanted effects to the commercial banks of a state. More vulnerabilities to security, cyber threats, fraud, etc could be initiated due to CBDCs. Moreover, there are many queries regarding how the personal data will be protected and in what way the government (or other entities) will have access to all the financial data & transactions.

What is the current state of CBDCs?

As this article is being written (October 2023), 11 countries have launched CBDCs, and over 100 countries are actively engaged in CBDC research for implementation.

Some of the notable examples of CBDC projects are:

The Bahamas: October 2023: The Central Bank of the Bahamas introduced the “Sand Dollar” as a digital legal currency equivalent to the traditional Bahamian dollar

China: 2014: Digital Currency Electronic Payment (DCEP) is a project by the People’s Bank of China (PBOC) to create a digital version of the yuan, China’s national currency. The goal is to replace some of the cash in circulation and enhance the efficiency and convenience of payments. DCEP has been under development since 2014 and has been tested in several cities and regions since 2020

Eastern Caribbean: The Eastern Caribbean Central Bank launched the CBDC known as “DCash” in March 2021.

Brazil: Drex is the name of the digital currency that is being developed by the Central Bank of Brazil (BCB) as a form of central bank digital currency (CBDC). Drex stands for digital, real, electronic, where the “x” potentially represents transactions. Drex is backed by the Brazilian fiat currency, the real (BRL), and is equivalent to it in value. Drex was initiated in 2020 and is expected to launch officially in 2024

Criticism

There is a lot of criticism about CBDCs and some of the questions asked are:

• How will CBDCs affect the privacy and security of users’ financial data? Will the government or the central bank be able to monitor and track every transaction made with CBDCs? How will users’ personal information be protected from hackers and cyberattacks?

• How will CBDCs impact the role and profitability of commercial banks and other financial intermediaries? Will CBDCs reduce the demand for bank deposits and other private money? Will CBDCs create unfair competition or disintermediation in the financial system?

• How will CBDCs influence the effectiveness and transmission of monetary policy?

• Will CBDCs enable the central bank to implement negative interest rates or helicopter money more easily? Will CBDCs create more volatility or instability in the money supply and inflation?

• How will CBDCs affect the international monetary system and the global balance of power? Will CBDCs challenge the dominance of the US dollar as a reserve currency and a medium of exchange? Will CBDCs facilitate cross-border payments and trade or create currency wars and fragmentation?

Conclusion

In conclusion, CBDCs are an emerging phenomenon that will definitely have significant implications for the future of money and finance. There are benefits to be considered but also several challenges and risks to be addressed.

In this post, we examined what CBDCs are, which countries already use them and mentioned some of the benefits as well as challenges. More analysis is needed and a lot of questions need to be answered before understanding in depth about what this may mean for the future of finance.

My suggestion?
Educated yourself, learn, discover cryptocurrencies to understand self-custody, be prepared and be judicious.

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More sources:
https://www.ecb.europa.eu/press/key/date/2022/html/ecb.sp220218_1~938e881b13.en.html
https://www.ft.com/content/31cbb97f-c3d3-4d1a-a365-e0c293c85f2b
https://www.bcb.gov.br/en/financialstability/drex_en
https://business.cornell.edu/hub/2021/01/13/chinas-e-currency-worlds-first-sovereign-digital-currency/
https://www.imf.org/en/Publications/fandd/issues/2022/09/Picture-this-The-ascent-of-CBDCs
https://www.federalreserve.gov/central-bank-digital-currency.htm

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