Wikipedia

Central bank digital currency

Not to be confused withStablecoin.

Acentral bank digital currency(CBDC;also calleddigital fiat currency[1]ordigital base money[2]) is adigital currencyissued by acentral bank,[3]rather than by acommercial bank.It is also a liability of the central bank and denominated in the sovereign currency, as is the case with physical banknotes and coins.

A sign on the Hangzhou Metro advertising acceptance of the Digital Renminbi
A sign on theHangzhou Metroadvertising acceptance of thedigital renminbi,the first CBDC adopted by a major economy (China)

The two primary categories of CBDCs are retail and wholesale.[4]Retail CBDCs are designed for households and businesses to make payments for everyday transactions, whereas wholesale CBDCs are designed forfinancial institutionsand operate similarly to central bank reserves.[4]

Retail CBDCs can be distributed through various models.[5]In the intermediated model, the central bank issues the CBDC and manages core infrastructures, while financial intermediaries offer customer services. The ECB and theFederal Reservehave proposed intermediated CBDCs.[6][7]Alternatively, the central bank could either provide the full service or delegate responsibilities further.[5]

The present concept of CBDCs differs fromvirtual currencyandcryptocurrencyin that a CBDC would be issued by astate.[8][9][10][11]Most CBDC implementations will likely not use or need any sort ofdistributed ledgersuch as ablockchain.[12][13][14]

In 2023, over 120 different jurisdictions, including major economies like the ECB, UK, and the US, were evaluating national digital currencies.[15]As it currently stands, 9 countries and the 8 islands making up theEastern Caribbean Currency Unionhave launched CBDCs; 38 countries andHong Konghave CBDCpilot programs;and 67 countries and 2currency unionsare researching CBDCs.[15]In the United States, some states have introduced legislation[16][17]to ban state payments using CBDCs withFloridabeing the first state to pass such a law citingprivacyconcerns.[18]

CBDCs have faced a plethora of criticisms among those being that a "centrally managed, centrally controlled, CBDC is a tool for coercion and control"[19]and that it would "allow the government to spy on" the citizenry.[20]

History

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See also:History of CBDCs by country

Although the term "CBDC" did not become widely used until after 2019, central banks have researched and launcheddigital currencyprojects for decades. For example,Finland's central bank issued the Avant stored value e-money card in the 1990s.[21]In 2014, theChinese central bankbegan researching the idea of issuing a CBDC.[22]Elsewhere, theEcuadoriancentral bank operated a mobile payment system from 2014 to 2018.[23]In 2021, Australia's central bank conducted a proof of concept for a wholesale CBDC usingEthereumto tokenize syndicated loans, aiming to automate and secure high-value transactions in the banking sector.[24]

Implementation

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A central bank digital currency would likely be implemented using adatabaserun by thecentral bank,government,or approvedprivate-sectorentities.[12][13][14]The database would keep a record (with appropriate privacy andcryptographicprotections) of the amount of money held by every entity, such as people and corporations.[12]

In contrast to cryptocurrency, a central bank digital currency would becentrally controlled(even if it was on adistributed database), and so ablockchainor otherdistributed ledgerwould likely not be required or useful - even as they were the original inspiration for the concept.[12][13][14]

By March 2024, the central banks of 134 countries accounting for 98% of the world's GDP were said to be in various stages of evaluating the launch of a national digital currency.[25]These included theECB,the UK, and the US.[26][27]China'sdigital RMBwas the first digital currency to be issued by a major economy.[28][29]Six central banks have launched a CBDC: theCentral Bank of The Bahamas(Sand Dollar), theEastern Caribbean Central Bank(DCash), theCentral Bank of Nigeria(e-Naira), theBank of Jamaica(JamDex),People's Bank of China(Digital renminbi), theReserve Bank of India(Digital Rupee), andBank of Russia(Digital Ruble).[30]TheCentral Bank of Brazilhas been rolling out tests of a digital Brazilian currency (Drex) since March 2023.[31]TheECB/Eurozonedecided in October 2023 to move forward to the preparation phase for the potential issuance of adigital euroafter a two-year study phase.[32]

Some states have also issued, or have considered issuing,cryptocurrencies:these includeVenezuela(Petro) and theMarshall Islands(Sovereign). These cryptocurrencies are often considered with the intent of increasing a state's independence from global financial systems, such as by reducing dependence on a foreign currency or by evadinginternational sanctions.[33][34]

Contrasting attitudes towards digital currencies were demonstrated by developments in the UK and Switzerland in February 2023. The UK Treasury and the Bank of England said a state-backeddigital poundwas likely to be launched some time after 2025. Two weeks later, a Swiss lobby group triggered a national vote on maintaining a "sufficient quantity" of cash in circulation over fears that electronic payments make it easier for the state to monitor its citizens' actions.[35]In a comment on the British government’s plans, the BBC'sFaisal Islamsaid the issue was about access to the data attached to every spending transaction, and whether people might choose to trust a global company more than the state: "The eye here is on maintaining UKmonetary sovereigntyagainst upheaval from the likes ofBig Tech."[36]

A major problem with central bank digital currencies is deciding whether the currency should be easily trackable. If it's traceable, the government has more control than it currently does. Additionally, there's a technical aspect to consider: whether CBDCs should be based on tokens or accounts and how much anonymity users should have.[37]

Characteristics

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A CBDC is a digital counterpart to fiat money, issued by central banks.[38]Likepaper banknotes,it is a means of payment, a unit of account, and a store of value.[39]And like paper currency, each unit is uniquely identifiable to preventcounterfeiting.[40]CBDC will have implications for commercial banks, probably in the field of lowering banks' commissions, no big customer data-selling ability, accumulating the deposits and deposit policies and credit policies due to higher funding costs for banks.[41]

Digitalfiat currencyis part of thebase moneysupply,[42]together with other forms of the currency. As such, DFC is a liability of the central bank just as physical currency is.[43]It is a digitalbearer instrumentthat can be stored, transferred and transmitted by all kinds of digital payment systems and services. The validity of the digital fiat currency is independent of the digital payment systems storing and transferring the digital fiat currency.[44]

Proposals for CBDC implementation often involve the provision of universal bank accounts at the central banks for all citizens.[45][46]

Benefits and impacts

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Governments and central banks are studying CBDCs and their implications for financial inclusion, economic growth, technology innovation, and the efficiency of bank transactions.[47][48]Potential advantages include:

  • Technological efficiency:instead of relying on intermediaries such as banks andclearing houses,money transfers and payments could be made in real time, directly from the payer to the payee. Being real time has some advantages:
    • Reduces risk:payment for goods and services often needs to be done in a timely manner and when payment verification is slow, merchants usually accept the risk of some payments not succeeding in exchange for faster service to customers. When these risks are eliminated with instant payment verifications, merchants no longer need to use intermediaries to handle the risk or to absorb the risk cost themselves.
    • Reduces complexity:merchants will not need to separately keep track of transactions that are slow (where the customer claims to have paid but the money has not arrived yet), therefore eliminate the waiting queue, which could simplify the transaction process from payment to rendition of goods/services.
    • Reduces (or eliminates) transaction fees:current payment systems likeVisa,Mastercard,American Expressetc. have a fee attached to each transaction and lowering or eliminating these fees could lead to widespread price drops and increased adoption of digital payments.
  • Financial inclusion:safe money accounts at the central banks could constitute a strong instrument of financial inclusion, allowing any legal resident or citizen to be provided with a free or low-cost basic bank account.
  • Preventing illicit activity:A CBDC makes it feasible for a central bank to keep track of the exact location of every unit of the currency (assuming the more probable centralized, database form)[49]
    • Tax collection:It makestax avoidanceandtax evasionmuch more difficult, since it would become impossible to use methods such asoffshore bankingandunreported employmentto hide financial activity from the central bank or government. In contrast, cryptocurrencies risk undermining effort to crack down on corporate tax avoidance.[50]
    • Combating crime:It makes it much easier to spot criminal activity (by observing financial activity), and thus put an end to it.[49]Furthermore, in cases where criminal activity has already occurred, tracking makes it much harder to successfullylaunder money,and it would often be straightforward to instantly reverse a transaction and return money to the victim of the crime.
  • Proof of transaction:a digital record exists to prove that money changed hands between two parties which avoids problems inherent to cash such as short-changing, cash theft and conflicting testimonies.
  • Protection of money as a public utility:digital currencies issued by central banks would provide a modern alternative to physical cash – whose abolition is currently being envisaged.[51]
  • Safety of payments systems:A secure and standard interoperable digital payment instrument issued and governed by a Central Bank and used as the national digital payment instruments boosts confidence in privately controlled money systems and increases trust in the entire national payment system[52][53]while also boosting competition in payment systems.
  • Preservation of seigniorage income:public digital currency issuance would avoid a predictable reduction ofseigniorageincome for governments in the event of a disappearance of physical cash.[54]
  • Banking competition:the provision of free bank accounts at the central bank offering complete safety of money deposits could strengthen competition between banks to attract bank deposits, for example by offering once again remunerated sight deposits.
  • Monetary policy transmission:the issuance of central bank base money through transfers to the public could constitute a new channel for monetary policy transmission[55][56][57](i.e.helicopter money[58]), which would allow more direct control of the money supply than indirect tools such asquantitative easingandinterest rates,and possibly lead the way towards afull reserve banking system.[59]In digital Yuan trial in Shenzhen, the CBDC was programmed with an expiration date, which encouraged spending and discouraged money from sitting in a saving account. In the end, 90% of vouchers were spent in shops.[60]Demurragecould be implemented, such as by shaving off fractions of the value on a scheduled basis, as a supplement to traditionalinflation targets.[61]
  • Financial safety:CBDC would provide an alternative tofractional reserve bankingfor daily uses, for those who want to avoid all risk ofbank runs,despite the relative safety provided bydeposit insurance.[62]

Risks

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Despite having potential advantages, CBDCs remain a controversial topic, and there are risks associated with their implementation.

  • Banking system disintermediation:With the ability to provide digital currency directly to its citizens, one concern is that depositors would shift out of the banking system. Customers may deem the safety,liquidity,solvibility,and publicity of CBDCs to be more attractive,[63]weakening the balance sheet position of commercial banks.[64]In the extreme, this could precipitate potentialbank runs[65]and thus make banks' funding positions weaker. However, theBank of Englandfound that if the introduction of CBDC follows a set of core principles, the risk of a system-wide run from bank deposits to CBDC is addressed.[66]A central bank could also limit the demand of CBDCs by setting a ceiling on the amount of holdings.[63]
  • Centralization:Since most central bank digital currencies are centralized, rather than decentralized like most cryptocurrencies, the controllers of the issuance of CBDCs can add or remove money from anyone's account with a flip of a switch.
  • Digital dollarization:A well-run foreign digital currency could become a replacement for a local currency for the same reasons as those described indollarization.[67]The announcement ofFacebook'sLibracontributed to the increased attention to CBDCs by central bankers,[68]as well as China's progress withDCEPto that of several Asian economies.[63]
  • Privacy:
    • "Governments have direct visibility of financial transactions",[69]an "eagle-eyed view on the spending of everyone".[70]
    • Digital currency would give a country "broad new powers when it comes to surveillance and controlling its population."[70]
    • Data from tracing money routes could lead to losing financial privacy if the CBDC implementation does not have adequate privacy protections. This could lead to encouraging of self-censorship, deterioration offreedom of expressionandassociation,and ultimately to stalling social developments.[71]
  • Government Social Manipulation:
    • Digital currency "will simply become an extension of the surveillance state" and "it could see citizens fined in a split second for behaviors deemed undesirable. Dissidents and activists could see their wallets emptied or taken offline."[69]
    • Limiting individual freedom: "Digital currencies could also empower the state to make it impossible to donate to a vocal NGO"[69]
    • Limiting or prohibiting purchases of products: Digital currency could prohibit a "purchase alcohol on a weekday."[69]
    • Digital currency "is also programmable. The government could theoretically give out money that expires within a certain period of time or money that could only be used on certain items, which could be used to induce behaviour that the government is seeking."[70]

See also

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References

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