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Central Bank Digital Currencies: A Patchwork of Progress and Lingering Concerns

Last Updated January 14, 2024 11:12 AM
Giuseppe Ciccomascolo
Last Updated January 14, 2024 11:12 AM

Key Takeaways

  • CBDCs have the potential to bring about significant changes to the financial system.
  • However, several challenges need to be addressed before they can be widely adopted.
  • China is a leading player in CBDC development, with its e-CNY pilot.
  • What’s the stock in the rest of the World?

The rollout of central bank digital currencies (CBDCs) is progressing at a varied pace across different regions. Developed countries facing concerns over the potential disintermediation of commercial banks and cybersecurity risks. Meanwhile, developing nations are focused on financial inclusion and remittance flows.

For developed countries, CBDCs offer the potential to enhance financial stability, provide new monetary policy tools, and provide better data for policymaking. However, concerns over disintermediation and cybersecurity risks are slowing down their adoption.

What Are CBDCs?

A central bank digital currency (CBDC) is a digital form of fiat currency issued by a central bank. This makes it distinct from decentralized cryptocurrencies. Still, in early development, CBDCs present potential benefits and risks.

Potential Benefits of CBDCs:

  • Enhanced Financial Inclusion: CBDCs can facilitate easier access to financial services, particularly for the unbanked or underbanked, by simplifying account management, payments, and loan access.
  • Improved Cross-Border Payments: CBDCs could expedite, lower costs, and enhance security for international payments, benefiting businesses engaged in global trade.
  • Enhanced Monetary Policy: CBDCs provide central banks greater control over money supply and interest rates, aiding effective management of inflation and economic growth.
  • Reduced Costs for Banks: CBDCs may lower payment processing costs for banks, potentially leading to reduced fees for consumers and businesses.
Source: Bank for International Settlements, Moody's Investors Services
The design and implementation of CBDCs requires the careful consideration of a few critical components.

Potential Risks of CBDCs:

  • Disruption to Banking System: CBDCs might reduce bank deposits, potentially impeding banks’ ability to lend, negatively impacting the economy.
  • Increased Surveillance: CBDCs could enable governments to monitor financial transactions more closely, raising concerns about privacy and data protection.
  • Financial Stability Risks: Poorly implemented CBDCs may pose risks to financial stability, such as a liquidity crisis if a significant number of people shift deposits to CBDCs.

In conclusion, CBDCs offer both benefits and potential disruptions to the financial system. A thorough evaluation of these advantages and risks is essential before deciding on CBDC adoption.

China At The Forefront

China has emerged as a frontrunner in the race to develop and implement a central bank digital currency, known as the e-CNY. The nation has been steadily expanding the scope of its e-CNY pilot program, onboarding more banks and institutions to participate in the testing and rollout of the digital renminbi. This ambitious initiative reflects China’s desire to establish itself as a global leader in the emerging field of CBDCs.

One of the key objectives of China’s e-CNY program is to enhance the effectiveness of monetary policy. By leveraging the programmability of the digital renminbi, the People’s Bank of China (PBOC) aims to achieve finer control over monetary transmission channels and target specific sectors of the economy more precisely. This could potentially lead to more efficient and targeted economic stimulus measures.

The PBOC has also highlighted the potential of e-CNY to promote financial inclusion, particularly among the unbanked or underbanked population in China. By providing a secure and accessible digital payment option, the e-CNY could extend financial services to individuals who may otherwise be excluded from the traditional banking system.

In addition to these domestic benefits, China envisions e-CNY  playing a role in international trade and remittances. The digital renminbi could potentially facilitate cross-border payments more seamlessly and efficiently, reducing transaction costs and improving the speed of money transfers.

Concerns On e-CNY

However, the development and implementation of e-CNY also present some challenges. One concern is that the widespread adoption of a CBDC could lead to disintermediation, as individuals and businesses may shift their deposits from traditional banks to the central bank. This could potentially weaken the banking sector and reduce its ability to provide credit to the economy.

Another concern is the potential for surveillance and privacy concerns. The programmability of CBDCs could allow the government to track and monitor individual transactions, raising concerns about data privacy and potential misuse of this information.

Despite these challenges, China remains committed to its e-CNY initiative, recognizing the potential benefits it could bring to the domestic and global economy. As the pilot program continues to expand and the technology matures, it will be interesting to see how China navigates the challenges and realizes the full potential of its digital currency.

The Digital Euro

The European Central Bank (ECB) has initiated a two-year experimentation phase to evaluate the feasibility and implications of a digital euro. This phase, which began in November 2023, involves testing various technical solutions and exploring potential use cases for the digital euro.

Similar to China’s e-CNY, the digital euro aims to enhance the efficiency and effectiveness of the European monetary system. It could facilitate cross-border payments, improve financial inclusion, and provide a more secure and resilient payment infrastructure.

However, the ECB is also carefully considering the potential risks associated with a CBDC. The main concerns here are banking disintermediation and surveillance. Disintermediation refers to the possibility that individuals and businesses may shift their deposits from traditional banks to the central bank, potentially weakening the banking sector and its ability to provide credit.

Surveillance concerns arise from the programmability of CBDCs, which could allow for granular tracking of individual transactions. This raises concerns about data privacy and the potential for misuse of this sensitive information.

To address these concerns, the ECB is proposing safeguards and limitations. These should ensure the digital euro complements rather than disrupts the traditional banking system. These safeguards could include limits on the quantity of digital euros individuals can hold and strict data privacy regulations.

The ECB’s experimentation phase is aimed at gathering insights into these issues and formulating a comprehensive strategy for the eventual implementation of the digital euro. The ECB recognizes the potential benefits of a CBDC but is also committed to ensuring that its introduction does not undermine the stability and efficiency of the European financial system.

US Has No Plan

In contrast to China and Europe, the US has yet to reach a definitive decision on whether or not to adopt a central bank digital currency, commonly referred to as a “digital dollar”.

The Federal Reserve (Fed), the central banking authority of the United States, has been actively conducting research and exploring the potential benefits and risks of a digital dollar. However, there is neither consensus within government, nor among financial institutions on the feasibility or desirability of such a move.

Proponents of a digital dollar argue that it could enhance financial inclusion, particularly among unbanked or underbanked individuals, by providing a secure and accessible digital payment option. Additionally, a CBDC could facilitate faster and more efficient cross-border payments, streamline financial transactions, and promote innovation in the payments landscape.

On the other hand, opponents raise concerns about the potential disruption to the existing banking system, the risk of surveillance and privacy violations, and the implications for monetary policy. They argue that a digital dollar could weaken the role of commercial banks in providing financial services. They also say it would increase government overreach into individual financial transactions.

Is Bitcoin A Threat To Digital Dollar?

The lack of consensus in the US is further complicated by the existence of a large and well-developed private digital currency ecosystem. This includes cryptocurrencies, like Bitcoin and Ethereum. These assets have attracted significant investment and user adoption, raising questions about the need for a government-issued digital currency.

Despite the ongoing debate, the Fed continues to research and evaluate the potential of a digital dollar. The central bank is exploring various technical approaches and considering potential safeguards. By doing so, it hopes to address the concerns raised by policymakers and industry experts.

Ultimately, deciding whether to adopt a digital dollar will depend on a careful assessment of the potential benefits and risks. It will also consider the specific circumstances of the US economy and financial system. The Fed and other stakeholders are likely to continue their deliberations in the coming years. They are carefully weighing the various factors involved in this complex decision.

A Wider Overview

In emerging economies, CBDCs hold the potential to enhance financial inclusion, lower transaction costs, and optimize remittance processes for the unbanked population. Multiple Latin American countries are actively exploring the viability and implications of CBDCs.

Brazil’s successful adoption of instant payment systems, exemplified by PIX, suggests a potential openness to CBDC adoption. However, challenges persist in terms of technological infrastructure, cybersecurity, and financial literacy in these nations.

The success of CBDC implementation hinges on institutional credibility, playing a pivotal role in overcoming these hurdles.

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