A Guide to Central Bank Digital Currencies (CBDC’s)
What if everyone had digital wallets?
At this point we have all heard about Bitcoin and Ethereum, the major cryptocurrencies in the world. Thousands of people try to invest even just a small portion of them, and as the popularity of cryptos starts to increase we continue to see how digital currencies can integrate in our daily lives. Now, imagine the Federal Reserve, the ultimate financial institution in the US, issuing a digital currency. What would that look like?
- What are CBDC’s?
First of all, it is important to know that CBDCs are the virtual form of a currency — such as the US Dollar and the euro. In other words, an electronic record or digital token in a country’s money supply. Because it is regulated by the monetary policy authority/central bank, it isn’t as volatile to market risk.
- Types of CBDC’s
There are two types of CBDC’s that would be in circulation: Wholesale and Retail CBDC’s. Wholesale refers to digital tokens issued exclusively for reserve deposits of financial institutions, while Retail refers to electronic money issued for the general public.
In that sense, the Harvard Business Review explains three main benefits to using Digital Currencies for the US Banking system. For instance, the end to paper cash and private bank deposits would shift the commercial and investment bank focus from consumer deposit competition to electronic wallet distribution strategies. Meanwhile, AI and data analytics would ease regulation and monetary policy, relieving some of the almost $15 billion of annual financial fraud. It would also facilitate inclusivity in the financial system –no bank account needed to make transactions with CBDC’s, only mobile internet connection.
The difference with this digital currency and crypto is the availability for conversion and traceability.
- Cryptocurrencies can be bought and sold as one wishes in exchange for USD, but a CBDC is a direct liability from the Federal Reserve and thus, unavailable for withdrawal.
- CBDC’s are not part of decentralized finance like crypto, but rather centralized finance, where the currency is controlled by the central bank. Consequently, every transaction remains traceable in the private ledger and anonymity is erased. All financial activity will be evident to the central bank.
Regardless, there is still much investigation to be done on the possible outcomes for CBDC’s in the global economy and financial markets. For such reason, the global CBDC tracker publicizes updated information on the research status.
Countries such as the US, Mexico, New Zealand, Brazil are still conducting research; Australia, Japan and Thailand have proof of concept; Saudi Arabia, Canada, and South Korea are already conducting pilot analysis.
Unique in the list of countries, however, is Nigeria. As of 2020, this country became a leader in cryptocurrency trade, reaching over $400 million on local crypto exchanges. Afraid for decentralization, the Nigerian Central Bank had prohibited all types of crypto exchanges for financial institutions. And now –less than 6 months ago — they have officially issued their Central Bank Digital Currency called eNaira. The reasons for the Nigerian government to implement such measures include efforts to solve economic problems caused by fluctuations in oil prices and a decrease in currency value against the US Dollar, in hopes that the eNaira would spark international trade, increase financial inclusion and strengthen payment systems.
Analysis for this implementation is still scarce, but many claim that cash continues to be the main means of transaction for Nigerians. Especially as there continues to be a lack of awareness about the uses and purposes of the eNaira.
For the US, the results could be much different. CBDC’s could spark innovation and competition in the financial services industry, or likewise have a slower impact like eNaira. Regardless, we should not discard preparing for a probable future with CBDC’s, where transactions can be made easier and faster by simply clicking on our phones.
Written by Luciane Muroya, a Finance & Accounting Management major at Northeastern University. LinkedIn: https://www.linkedin.com/in/luciane-muroya-723ba0200