Will Central Bank Digital Currencies Survive?

Central bank digital currencies or CBDCs are government-backed digital versions of a country’s fiat currency. One of their main advantages is being able to provide more inclusive, reliable, and secure digital transactions and remittance, while also being less volatile than cryptocurrencies, which are decentralised and unregulated by a single authority.

However, their potential introduction also raises questions over how they can be successfully integrated into existing banking systems without destabilising them; and whether they would require increased surveillance of transactions, leading to privacy and security concerns.

A number of countries have already launched digital currencies, albeit with varying motives, approaches and successes. Indeed, more than 80% of central banks are said to be launching a CBDC or have already done so, according to the 2022 PwC Global CBDC Index.

We have had digital currencies in the form of credit cards for a long time. They work well, it is just that they are very expensive and are only accessible by a limited portion of the population.

Douglas Heintzman, Chief Catalyst, Blockchain Research Institute

Inclusivity a key benefit of CBDCs

A key benefit of CBDCs is that they can be “more inclusive and make financial and banking services more accessible to more of the world’s population,” says Douglas Heintzman, chief catalyst at the Blockchain Research Institute.

Some 1.7 billion people around the world are unbanked and one of the most widely-touted potential benefits of CBDCs is helping such individuals create financial identities by enabling people to build credit and access financial instruments previously unavailable to them.

CBDCs could also vastly improve payments infrastructure, reduce costs, improve the security and transparency of transactions, and help mitigate risks such as counterfeiting and money laundering.

They could also provide central banks with a more accurate view of monetary risks through digital monitoring, potentially enabling them to implement policies to ensure stability, influence inflation and control or stimulate growth.

Downsides of digital currencies

Critics argue that some benefits do not hold up to scrutiny as the effects of a switch to CBDCs on the wider economy and financial system are still largely unknown.

In 2022, for example, a UK parliamentary report warned that without safeguards such as limits on the amount of CBDC individuals can hold, financial instability could be exacerbated during periods of economic stress and trickle down to households.

“The fact is that every dollar or euro held as a CBDC is a dollar or euro not held at a bank in a deposit account,” warns Nicholas Anthony, of US think-tank the Cato Institute.

“In practice, this can result in banks not just losing customers, but also losing the ability to issue as many loans. Looking at broader society, people would then likely experience higher interest rates, more fees and even a reduction in the credit or loans available.”

Others highlight the potential need of increased surveillance of transactions and ask how anti-money laundering systems that are fundamental to our existing financial systems can be transferred to digital currencies, without compromising privacy and security.

In addition, threats of cyber attacks will inevitably rise as our economies and societies become increasingly digitised. As such, there is going to have to be an increased focus on cyber security for everything, especially digital currencies, going forward.

The fact is that every dollar or euro held as a CBDC is a dollar or euro not held at a bank in a deposit account. In practice, this can result in banks not just losing customers, but also losing the ability to issue as many loans.

Nicholas Anthony, Policy Analyst, Cato Institute

Countries experimenting with CBDCs

The Bahamas in 2020 launched the sand dollar in order to serve un-and under-banked populations, reduce service delivery costs and increase transactional efficiency.

The central bank later reported that there was an adoption rate of about 7.9% and a positive correlation between the CBDC and financial inclusion. However, an International Monetary Fund report in 2022 said that the sand dollar made up just 0.1% of Bahamian currency in circulation, adding there were “limited avenues” to use it.

In 2021, Nigeria launched the eNaira as a less costly, more efficient and safer means of payment in a country where the World Bank estimates that nearly 64 million of its nearly 200 million population are unbanked.

A year on, just 0.5% of the population were using the CBDC as many Nigerians still preferred cash. It wasn’t until the central bank created a cash shortage that adoption jumped 12-fold to 13 million users.

China is testing a CBDC in 17 provinces in what is the world’s biggest pilot of its kind, and plans to further expand it this year. It was launched not only to compete against services such as AliPay, but also to expand the economic activities included in the state payments network and with an eye towards setting global technical and regulatory standards.

Australia, Brazil, India, Russia, South Korea and Thailand are also intending to start or continue CBDC pilots this year. And Sweden launched an e-krona pilot in 2020 but an official inquiry recently concluded the case for CBDC was not yet strong enough.

Are CBDCs here to stay?

The exact future of CBDCs may yet be unwritten but they have certainly gained momentum and look set to become increasingly prominent across the world.

Experts such as Anthony, of the Cato Institute, argue that the promised advantages of CBDCs – such as financial inclusion, faster payments and improved monetary policy – are unlikely to come to fruition, particularly when costs are high and benefits are low.

Others argue that the move towards CBDCs is a natural progression of digitalisation. “We have had digital currencies in the form of credit cards for a long time. They work well, it is just that they are very expensive and are only accessible by a limited portion of the population,” says Heintzman, of the BRI.

“A more effective, efficient, and inclusive digital currency is inevitable and has many advantages,” he adds. “Today’s digital currencies have already had a profound effect on society. Tomorrow’s CBDCs and stablecoins will have an even greater effect.”