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What are central bank digital currencies?

Fears over cryptocurrencies’ impact on financial stability are driving development around the world

What are Central Bank Digital Currencies?

Central bank digital currencies, or CBDCs, are an attempt to bring some of the purported upsides of private digital currencies to the world of public money, under the auspices of national central banks. This also means that CBDCs will, in theory, be safe in times of financial crisis.

Comparisons are often made with cryptocurrencies, as some proposed CBDCs could make use of the same blockchain technology. This is not necessarily the case, however. In fact, unlike the best known blockchain — that used by bitcoin — which is essentially a decentralised database, central banks in most cases are likely to control their own private blockchains.

How far have plans progressed?

While there are few fully developed and deployed CBDCs, several countries have initiatives at advanced stages. In China, the e-yuan CBDC is one of the most advanced among large economies. In February, the government handed out lunar new year “red packets” containing the digital coins to encourage uptake.

One of the few countries with a fully deployed CBDC is the Bahamas, whose Sand Dollar was piloted in 2019 and launched properly a year later, as a collaboration between the central bank, payment card group Mastercard and digital payments platform Island Pay.

Other leading economies in Europe and North America are still at the exploration stage. In the UK, the Bank of England and the Treasury announced a CBDC task force to co-ordinate studies of a potential “Britcoin”, though it has yet to present any concrete findings. In the US, Federal Reserve chair Jerome Powell said in September that the central bank would “soon” release research on the costs and benefits of deploying a CBDC. Cryptocurrencies have become an increasingly polarised topic in the US, with similar division reported among Fed officials on the idea of a public digital currency.

Why are governments trying to create CBDCs?

The impetus for CBDCs in western countries has been inspired, at least in part, by two potential challenges — the first driven by fears over private companies outstripping regulators’ powers and the second by geopolitical concerns.

Stablecoins pegged to US dollars have seen massive uptake over the past year. The nominal value of their coins in circulation has risen from less than $30bn to about $140bn. While much of that is kept within the cryptocurrency ecosystem, there are growing efforts to use stablecoins for quick, cheap transfers.

Novi, the digital wallet from Meta (formerly Facebook), is trialling the pax dollar stablecoin for transfers, including remittances in Guatemala and parts of the US. (Meta’s own stablecoin, diem, is yet to launch — concerns about a coin owned and operated by the social network have been central to stablecoin regulation.)

Regulators have raised concerns about private stablecoins on several fronts, including the challenges they might pose to financial stability and the effectiveness of monetary policy, as well as consumer welfare. Some believe an effective CBDC might reduce consumers’ desire to rely on stablecoins, or at least offer greater protection for retailers.

There are also concerns about China’s e-yuan project, one of the more advanced CBDC initiatives. Beijing aims to expand the system ahead of the Beijing Winter Olympics in February. Critics in the US have voiced fears that its deployment would allow the Chinese government to block shoppers from using the coin at stores that fell foul of their policies, as well as allowing for mass surveillance.

Proponents of CBDCs say they offer benefits that have often been attributed to stablecoins, including lower costs and faster payment settlements than existing systems in some parts of the world. There is also discussion about their ability to implement monetary policy more effectively, such as providing economic stimuli after financial crises.

What are the risks?

One concern around CBDCs is the potential impact on traditional retail banks. If consumers have access to liquid cash, fully backed by central banks, CBDCs may become a safe haven in case of economic instability, thereby taking cash out of banks and potentially leading to bank runs.

In a similar vein to concerns around Beijing’s control of the e-yuan, there are debates around the ethics of “programmable money”. If a central bank has the ability effectively to control consumer spending, this could potentially undermine fundamental rights and free choice.

Finally, there is a longstanding concern over financial inclusion that has only grown during the pandemic, as efforts to digitise money have been supercharged. CBDCs may be beyond the reach of those with older devices or without access to digital wallets, requiring care to avoid further disenfranchising the old and vulnerable.

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