Since the 2008 birth of bitcoin, which came soon after the global financial crisis, cryptocurrencies have become increasingly popular. The blockchain, which powers cryptocurrencies, enables peer-to-peer transactions in a safe manner without the need for a reliable third party, which promises to increase efficiency. A central bank digital currency (CBDC), which is digital legal tender based on blockchain technology, is something that several central banks are looking into the possibility of introducing.
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Since the 2008 birth of bitcoin, which came soon after the global financial crisis, cryptocurrencies have become increasingly popular. The blockchain, which powers cryptocurrencies, enables peer-to-peer transactions in a safe manner without the need for a reliable third party, which promises to increase efficiency. A central bank digital currency (CBDC), which is digital legal tender based on blockchain technology, is something that several central banks are looking into the possibility of introducing.
How central bank digital currency is different from others?
It is important to keep in mind that electronic money has been around for a while, which can be used for things like internet purchases, credit card transactions, and e-banking. The manner in which transactions are settled, however, is one significant distinction between digital money and the CBDC. Currently, only financial institutions are allowed to handle and pay consumer transactions. Due to the financial institution acting as a middleman in the transaction, the client is therefore exposed to the risk of default. But in the case of a direct central bank digital currency , the CBDC asserts a direct claim against the central bank that issued it, and the central bank manages all retail payments. This feature suggests significant socioeconomic effects.
Types of Digital Currency
There are three types of central bank digital currency structures viz. the direct, the hybrid, and the indirect CBDC.
Direct: The holder of a direct central bank digital currency has a direct claim against the central bank that issued it and is in charge of processing all retail payments. The onboarding of users is the responsibility of the financial intermediaries or the central bank itself.
Indirect: The intermediary’s claim is completely backed at the central bank according to the indirect central bank digital currency. In this arrangement, only wholesale payments are handled by the central bank. The onboarding of new clients and the settlement of retail payments are within the purview of the intermediaries. Thus, the indirect CBDC design is similar to the existing two-tier banking system, with the exception that it runs on a cutting-edge technology called the blockchain.
Hybrid: Real-time payments are handled by intermediaries in the hybrid CBDC, which has a two-tier structure with direct claims on the central bank. Onboarding and managing retail payments are under the purview of the intermediaries.
Who are the main stakeholders here?
In order to analyze the socio-economic impact of central bank digital currency, we should know what are main stake holders, which include central bank, private banks, firms, and consumers.
Digital Currency and Consumer
One benefit is that CBDC offers “easy real-time payments” and “cash-like functionality” with “strong underlying technology” (blockchain or traditional infrastructure) to provide “resilient and robust operations.” The CBDCs should be “available to everybody” and “protect privacy in lawful exchange” when choices are made about how to handle customer information. The issue of whether CBDCs enable cross-border payments also becomes crucial.
For this reason, the fundamental tenets of CBDCs for retail payments include being dependable and durable, quick and efficient, as well as inventive and welcoming to competition.
The existence of interest-bearing CBDCs, which are referred to as “cash-like” because modern bank notes and coins do not bear interest, is another crucial factor to take into account.
Digital Currency and Central Banks
Digital currencies like CBDCs may be viewed as a new instrument for central banks for implementing monetary policy. According to some writers, CBDCs “may include characteristics that can possibly equate to handing new powers to central banks, such as having increased surveillance authority over transactions and imposing negative interest rates, which would otherwise be absent or limited.”
From the perspective of the central bank, there are several opportunities, including supporting a robust payment landscape, avoiding the risks of new forms of private money creation, promoting competition, efficiency, and innovation in payments, meeting future payment needs in a digital economy, increasing the accessibility and usability of central bank money, addressing the repercussions of a decline in cash use, and CBDC could serve as a foundation for better cross-border payments.
The provision of a programmable feature to CBDCs based on the use of smart contracts may be a further significant benefit. This would enable automatic cash flow or interest payments.
What potential dangers may a CBDC’s introduction bring? Risk of disintermediation (moving from deposits to CBDC, endangering private banks and reducing credit available to businesses and families), financial instability due to a quick shift from deposits to CBDC (e.g., digital bank run).
Digital Currency and Financial Entities
By enabling a peer-to-peer financial system without the need for financial intermediaries, the prospective adoption of a CBDC has the potential to upend the established business models for the retail banking sector. As a result, CBDC raises pressure on banks to adopt FinTech businesses’ innovations while also increasing the possibility that the banking industry would lose its systemic edge.
The P2P lending platforms in the USA are only one example of the fierce competition that banks already face from FinTech firms. They effectively allow for the granting of credit without the need of banks as intermediaries. With the launch of a direct CBDC, this P2P lending might become much more significant since it would allow for a CBDC-based P2P lending that is equivalent to borrowing actual cash from a buddy.
In the long term, all these disruptive tendencies would result in the creation of a platform economy, which would allow a CBDC to provide a wide variety of consumer-focused financial services through a partnership business model that includes all stakeholders.
Conclusion
In connection with payment transactions, there are a number of potential associated to CBDCs that have been noted, including increased cash flow efficiency and decreased transaction costs. Additionally, it is anticipated that the establishment of CBDCs would make it easier for private digital payment providers to get financing as well as improve the traceability and oversight of payment transactions. The anticipated advantages in terms of monetary policy relate to a better monetary control as a result of the real-time data collecting.
In contrast, a number of socioeconomic difficulties related to CBDCs have been discovered, including higher costs for dealing with cybersecurity vulnerabilities, combating money laundering abuses, and guaranteeing system resilience. The implementation of a CBDC also presents a very difficult task, specifically how to change the legacy payment infrastructure that now exists without endangering the whole financial system.
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