The latest technological advancements are giving access to more widespread use of digital currencies in the not-too-distant future. In recent years, payment technology has made progress and continues to develop at an accelerating pace. Not so long ago, it was common to make payments by cheque or cash. These continue to play a significant role in the settlement of transactions, but new technologies such as digital currencies are presenting major disruption to traditional bank-based payment systems.
Cryptocurrencies and their growing popularity have made new technologies significant in our everyday lives. As a result, the world’s major central banks are currently exploring the possibility of issuing digital currencies for citizens and businesses to make everyday payments and electronic transactions. Although the concept of ‘digital currency’ is usually linked with cryptocurrencies such as Bitcoin, Central Bank Digital Currencies (CBDCs) have little in common with them. CBDCs are issued and guaranteed by central banks, meaning their value is stable and safe, just like banknotes and traditional coins. One US dollar in cash would be the equivalent to one US-denominated CBDC.
“These are still early days for CBDCs and we don’t quite know how far and how fast they will go. What we know is that central banks are building capacity to harness new technologies—to be ready for what may lie ahead.” – Kristalina Georgieva
What form would these central bank digital currencies take and what would be their usefulness?
The evolution of cryptocurrencies has shown there is a demand for these types of financial instruments that can be used as money, even if they are issued by non-governmental entities. In any case, the issuance of CBDCs will require careful assessment of the opportunities as well as the risks, as they may have a significant impact on the functioning and stability of the financial system. In some cases, banknotes could be substituted by digital central bank money, which is easier to store than cash, but it could alter the structure of commercial banks and their ability to provide credit to the real economy.
More and more central banks are in the process of issuing their digital currencies. China is already running tests for its digital Yuan in several cities and has been noted to potentially challenge the dollar’s denomination of international trade settlements in the next decade, according to CNBC.
Japan has announced that it will examine the technical possibility of issuing a CBDC. In addition, the European Central Bank published a report on the digital euro, which stated they are prepared to issue a CBDC in the future and will decide whether to start a research phase to develop a viable product to use as a form of payment but not as a form of investment.
Why are central banks interested in digital currencies?
Several reasons triggered central banks to develop the idea of issuing their digital currencies:
- Competition. Competition between central banks is an important factor, as none of them want to be left behind if a foreign CBDC gains power and poses a threat to their domestic currencies and autonomy. There is a similar threat posed by private digital currencies, especially those with a global reach driven by large tech companies.
- Fear. Central banks fear the gradual shift away from the use of cash as a means of payment will eventually relegate legal tender (the banknotes and coins they issue) to irrelevance and create an over-reliance on digital money.
- Opportunities for Innovation. Some central banks also point to the opportunities for innovation and efficiency in payments as a motivation for issuing a digital currency, which would be a huge step towards a fully digital economic environment.
At the end of the day, the possibility that central banks will decide to issue their digital currency in the future is a paradigmatic example of how technological developments can alter the current system. In the coming years, main central banks and financial institutions will be following these developments very closely and will have to decide whether to issue their cryptocurrencies. To be able to make this decision, central banks will have to consider consumer preferences for privacy and efficiency in payments, clearing, and settlement, as well as the risks to the financial system and the economy as a whole.