Central Bank Digital Currencies: Everything You Need to Know

Bitcoinwas invented, at least in part, to evade governments and national currencies. In theoriginal white paper, released in the wake of the 2008 financial crisis, Satoshi Nakamoto expressed a desire to create “a new electronic money system” that was “completely decentralized with no server or central authority.”

but if cryptocurrenciesgaining popularity, taking an ever-increasing slice of the global financial pie, governments have noted, and now many of them are exploring how to get a slice of the action.

In the US, the Federal Reserve is planning a review of the potential benefits and risks of what’s called a CBDC, or central bank digital currency, according to a report from The Wall Street Journal. This so-called digital dollar is said to contain elements of decentralized cryptocurrencies, such as bitcoin, but with one major difference: it is issued and regulated by the country’s financial authority.

And the US is not alone. There are dozens of countries at some stage of research on CBDCs, according to Kristalina Georgieva, director of the International Monetary Fund.

But CBDCs are complex. They offer a number of potential benefits (for example, by providing financial resources to underbanked populations) and potential drawbacks (including significant privacy concerns). For now, here’s an introduction to some of the basics, as well as an overview of which countries are working on CBDCs and some pointers on how a central bank digital currency might work in practice.

What is a central bank digital currency?

It’s the virtual form of a fiat currency — that is, government-issued money that isn’t backed by other commodities like gold or silver. Basically, a CBDC is just the digital form of a country’s official currency. As nothing more than a computer code, these currencies can be stored in central ledgers within a country’s national bank or in a distributed ledger like private cryptocurrencies such asbitcointo be.

What factors stimulate interest in CBDCs?

The rise of cryptocurrencies serves as a wake-up call for national governments, which have long held a monopoly on currency issuance. According to Gustav Peebles, a professor of anthropology and an expert in monetary history, theory and policy at The New School in New York City, concern about the threatened monopoly appears to be what is driving interest in CBDCs.

“Currencies throughout history can be issued by the public or by private entities, and what crypto has shown or brought to us is a revival of an age-old battle between issuance of private and public currency,” said Peebles. “Central bankers were suddenly caught off guard, and so a central bank digital currency is central bankers trying to hold on to their monopoly on currency issuance in the face of the erosion of that monopoly.”

How would a digital dollar work in practice?

Americans today use and carry less cash, opting instead for card and electronic payments. survey by the Cash Product Office of the Federal Reserve System. Mobile payment services such as Venmo, cell andpaypalare growing in popularity, with 64% of respondents saying they regularly a digital payment platform, according to a2020 Survey by the Travis Credit Union.

But what if you don’t have to go through your bank or any third-party platform to pay or store your money?

That’s what the digital dollar would promise. CBDCs could circumvent the traditional banking system by allowing money stored with the Federal Reserve to flow directly between parties, much like exchanging cash or transferring money electronically.

However, the logistics are not yet complete. One option is for the Federal Reserve to issue digital wallets to Americans, making money accessible through a smartphone app or debit card, Peebles said. El Salvador did this in the fall by giving Salvadorans access to a crypto wallet app called Chivowhen itadopted bitcoin as legal tender in the country.

The money would essentially be in an account you would have with the Federal Reserve or an entity such as a private bank that the Federal Reserve partners with. If you paid for something, the Federal Reserve would take money from your digital wallet and deposit it directly into the other party’s digital wallet, bypassing the complex web of networks currently involved in electronic payments. As a plus, this would remove the fees generally associated with such payments.

US digital wallets would turn commercial banking on its head

However, digital wallets issued by the Fed are said to be a destabilizing form of CBDC. “It really messes with the general pyramidal structure of central banking as a concept, which has always been that central banks are not bankers to the average citizen,” Peebles said. As a rule, central bankers oversee the banking system, while private banks interact with consumers.

Such a shift would be destabilizing, Peebles noted, because if the average person can make daily payments through a Fed account, there’s less reason to hold an account with a private bank. “That could push private banks away from what they’ve gradually turned into today — this deposit facility — and return them to their original job: just lend,” Peebles said.

A less destabilizing CBDC proposal wouldn’t require a federal bill, but would include a “cash card” — a card that retail bank customers could use at ATMs to load digital cash instead of paper money. “Like paper money, if the holder lost that card or had their wallet stolen, the card would have a value that anyone could use,” Peebles said.

CBDCs would help unbanked households

As of 2020, 5% of U.S. adults, or about 16 million individuals, did not have a bank account, meaning they depend on non-banking products and services for cash, according to the Federal Reserve. 2020 Survey of Household Economics and Decision Making (BARN). Underbanking rates were higher among black and Hispanic adults and among those from historically excluded low-income groups. For those who have a bank account, it is already possible to set up a direct deposit with the government for federal money, such as tax refunds or incentive payments. With a CBDC, the Federal Reserve could immediately make such funds available by depositing them into a digital wallet, regardless of whether the person had a bank account.

Privacy Concerns About CBDCs

The biggest concern about a government-issued digital dollar revolves around privacy, especially when it comes to issuance of Federal Reserve bills. The US government could track all citizens’ purchases through an e-wallet, give the Fed an overview of everything we do and eliminate space for unmonitored money exchange, Peebles said.

If the U.S. government watches everything you buy — from milk at your local store to poker chips on your next casino visit — there’s potential for abuse. “All sorts of profiling could come from that, and hackers could see that database as quite valuable as well,” Peebles said. “For example, you could imagine predatory marketing to the elderly if the data got out.”

A potential bottleneck could be if people use their Fed accounts to buy illegal goods, such as cannabis. Although states across the country have legalized cannabis for medical and recreational use, it is still illegal at the federal level. In theory, if someone bought the substance from a pharmacy with digital dollars, the government could decide to impose criminal penalties for the transaction.

Which Countries Are Investigating CBDCs?

About 110 countries are at some stage of CBDC development, according to the IMF. The Bahamas,Nigeria and several countries in the Eastern Caribbean through the Eastern Caribbean Currency Union (including Grenada, Antigua and Barbuda, Saint Lucia and St. Kitts and Nevis) have already issued CBDCs. The names of their e-currencies are the sand dollar,eNaira and DCash, respectively.

China, which Cryptocurrency banned this year, is leading the package “in development” with the digital yuan, having trialled more than $5 billion worth of transactions since June 2021. China has conducted several real-world trial runs to test the “reliability of economic theories, the stability of systems and the manageability of risks,” according to a recent report by the People’s Bank of China. These pilot runs include giving digital yuan to a random group of applicants to spend at designated offline locations or on the site of China’s largest online retailer, JD.com.

Rather than adopting its own digital currency or CBDC, El Salvador recently made bitcoin legal tender, which means that the established cryptocurrency should be accepted as a means of payment across the country. Shortly after, Panama followed in El Salvador’s footsteps andrevealed a similar plan to make bitcoin legal tender.

The US is expected to take a big step forward by launching its own assessment of the potential benefits and risks of issuing an all-digital dollar, according to a report last month by The Wall Street Journal. The Fed has not yet announced when it will make a decision on a CBDC.