Future Outlook: CBDCs Vs Cryptocurrency

To determine if Central Bank Digital Currency (CBDC) systems can be used for cross-border payments, the Bank for International Settlements (BIS) conducted experiments. In its 2022 Annual Economic Report released on Tuesday, June 21, the BIS argued that while cryptocurrencies introduce real advancements like programmability and tokenization, decentralization does not contribute toward its effectiveness.

“Our broad conclusion is captured in the motto, – Anything that crypto can do, CBDCs can do better,” 

said Hyun Song Shin, the BIS’s head of research and economic adviser.

The report reflects BIS’s perception of cryptocurrency: It has some inherent flaws that render it unable to serve as the foundation of a monetary system, while CBDCs represent the future with its ability to selectively inherit cryptocurrency’s advantages.

When asked about his trust in CBDCs and the results of the BIS’ own tests thus far, Shin reacted with optimism, adding that nations were opting to issue CBDCs despite having reliable payment systems.

The diversion from Bitcoin and other cryptocurrencies is not incentivized by their fluctuant value alone; it stems from its decentralized nature. Will the users of cryptocurrencies and stablecoins share the same standpoint?

Definition of a CBDC

A CBDC is a digital version of fiat currency. It is issued by a central bank and credited by the government, much like fiat currency. A CBDC is never printed, however, rendering the forms of minting and exchange also different. According to the CBDC tracker of AtlanticCouncil.org, 105 countries, representing over 95 percent of global GDP, are exploring a CBDC, 10 of which have fully launched one. More than a dozen nations are presently testing CBDCs. The majority of them include collaborations between central banks, commercial banks and IT consulting firms, while the most sophisticated ones involve wholesale cross-border CBDCs.

AtlanticCouncil.org: CBDC development status worldwide

CBDCs are not to be confused with cryptocurrencies and stablecoins. Stablecoins are a different kind of cryptocurrency whose value is tied to an asset or a fiat currency such as the dollar. Like cryptocurrencies, stablecoins operate via distributed ledger technology, which means that several devices throughout the globe, rather than a single central hub, continuously check the validity of transactions. 

Why CBDC?

A well-established CBDC might be more effective than current solutions. CBDCs are blockchain-based. Blockchain transactions are significantly cheaper than fiat and traditional transactions. Moreover, storing digital currency is less demanding than fiat currency.

As global adoption grows, CBDCs might speed up, decrease costs, and increase the accessibility of cross-border payments by removing intermediaries required to execute a transaction.

A recent white paper published by the Federal Reserve Bank of Boston and the Massachusetts Institute of Technology demonstrate that a CBDC may be structured to settle an exceptionally large volume of transactions in a short duration, demonstrating that a CBDC at scale is technically viable.

According to the paper, a CBDC might provide benefits not accessible from current payment systems or stablecoins. A CBDC, as a Federal Reserve obligation, would be the most secure sort of digital money available to the public. It would have no credit or liquidity risk and would not, for example, require deposit insurance or asset pool support to sustain value. Payments for products and services might be made by users such as consumers, corporations, and governments. Governments can use CBDCs to collect taxes and make social program payments.

Although adding programmability on top of the other benefits of CBDC grows its potential in the current financial race, it’s not all sunshine and roses in a world where CBDC is the only digital currency. 

Why Not CBDC?

The same report warns that an interest-bearing CBDC might disintermediate banks, jeopardize financial system stability, and complicate monetary policy execution. There are also reasons why the users may not come to favor it over Bitcoin and private tokens.

A CBDC would produce data on user transactions to make it easier to comply with anti-money laundering (AML) and combating the financing of terrorism (CFT) rules and regulations. Besides the fact that such data would need to be safeguarded, users may have privacy concerns that the amount of data collected with crypto transactions is marginal, in comparison.

One of the main potential difficulties with CBDC issuing is the legal and regulatory elements. Some jurisdictions’ current legal framework may forbid or restrict the issuance of CBDCs. According to a report by the Saudi Central Bank, several central banks claim that while they have the legal authority to issue a CBDC, the legislation still has to be changed in order to address various legal concerns relating to the particular characteristics of CBDCs, such as programmability and privacy.

In an overview of the motivations and challenges of CBDC by the BIS, the financial literacy of the public was highlighted as one of the critical challenges opposing the success of CBDC issuing, particularly for central banks, whose principal goal in issuing a CBDC is to promote financial inclusion. Even though a country’s digitalization in everyday life and the financial services industry has improved, this does not necessarily indicate an improvement in financial literacy among its citizens. It may turn out to be more difficult for some parts of the population to access and use new technology and related digital services, which, if not handled effectively, may result in the financial exclusion of certain segments.

Some nations have adopted CBDCs and more are on the way. All the signs say that CBDCs will happen. They are both comparable to and unique from existing cryptocurrencies. They are paperless, similar to bitcoin, and backed, similar to stablecoins. They are, however, centralized, unlike bitcoin, and government-issued, unlike stablecoins.

EY (Ernst & Young) advised banks to modify their regulatory boundaries in order to prepare for the impending releases of private stablecoins and state-backed CBDCs in its most recent report on the status of global regulation. Central banks are up against a number of factual concerns. The success of CBDCs is tied to their potential to become popular with users, especially those of solid ground alternatives like stablecoins. Banks may need to work closely with treasury functions to adapt and act fast toward current and new concerns as they arise.