A central bank digital currency (CBDC) is a new type of public money based on digital technology. Simply put, it is a digital currency issued by a national bank that is legal tender. In the same way as a fiat currency, a CBDC is controlled by a central bank to regulate fluctuations and maintain economic stability.
Why central bank digital currency (CBDC) matters
Let’s analyze the facts of the last two decades. Exactly twenty years ago, Paypal was born, the precursor of all current Fintechs. In two decades this tool, reliable and secure in online transactionsTransaction Exchange of value, property, or data between two parties. and P2PP2P P2P stands for Peer to Peer. A peer-to-peer network allows users to exchange data without intermediaries. payments, has grown to exceed 250 million active accounts but has never affected the banking sector or even that of the payment circuits of large credit card companies such as Visa or MasterCard. Because, exactly like the current Apple Pay, Samsung Pay or Google Pay, to work it must interface with a pre-existing card (no matter whether credit, debit or prepaid) or with a current account, effectively operating as a parallel virtual account powered by traditional banking instruments. Then things start to change.
In 2004, Alibaba Group launched an online payment platform called Alipay in China.
In 2016, Facebook obtained an electronic money institution license in Ireland, while Amazon Payments Europe had a license issued in Luxembourg.
In 2018, Google receives the electronic money institution license from the Bank of Lithuania. License valid for the entire European Union.
In 2022, PayPal announced that it would begin supporting cryptocurrency payments for its US users. PayPal customers can now buy, sell and hold cryptocurrencies such as Bitcoin, Ethereum, Litecoin and Bitcoin Cash. PayPal also allows customers to use cryptocurrencies to make payments to merchants who accept PayPal. As for cross-border payments, PayPal is working with Paxos, a cryptocurrency company, to develop a way for customers to send money to other countries using cryptocurrencies. This service is expected to launch in 2024.
In 2023, Stripe announced that it would begin supporting CBDC payments for merchants operating in countries that have launched a CBDC. Stripe is working with central banks in several countries to develop CBDC payment solutions. For example, Stripe is working with the Bank of England to develop a way for merchants to accept payments with sterling digital CBDC.
In addition to Big Tech, fintechFinTech Sector that combines finance and technology, whose companies develop technologically innovative financial services. companies such as Stripe, TransferWise and Wirex (which has a cryptocurrency-based payments platform) have also moved in this direction.
In short, first in the United States and Asia, then in Europe, the so-called GAFAM, i.e. Google, Apple, Facebook, Amazon and Microsoft (but not only them) ask for licenses for monetary transfers, digital payments and financial activities. Lithuania has issued 39 licenses so far, although the UK is going even faster, issuing 128.
At the same time, cryptocurrencies are becoming increasingly widespread, which are generally produced outside the banking perimeter.
The payment system is therefore not static but, on the contrary, has always been in continuous evolution.
Obviously, traditional banks have also moved in this context with Central Bank Digital Currencies (CBDC), i.e. digital currencies issued, or as they say “printed”, by central banks. According to the Atlantic Council (https://www.atlanticcouncil.org/cbdctracker/), today (2023) 130 countries, representing 98% of global GDP, are exploring a CBDC. As of May 2020, only 35 countries were considering a CBDC. A new high of 64 countries are in an advanced stage of exploration (development, pilot or launch).
19 G20 countries are now at an advanced stage of CBDC development. Of these, 9 countries are already in the pilot phase. Nearly all G20 countries have made significant progress and invested new resources in these projects over the past six months.
11 countries have fully launched a digital currency. The Chinese pilot project, which currently reaches 260 million people, is being tested in more than 200 scenarios, some of which include public transportation, stimulus payments and e-commerce.
The European Central Bank (ECB) launched its CBDC research project in 2021. The project is currently under development and plans to test a CBDC for retail payments.
China was one of the pioneers in the development of CBDCs. The Central Bank of China (PBoC) launched its CBDC research project in 2014. The PBoC has already tested a CBDC for retail and wholesale payments. The tests involved over 100 million people and 1.5 million businesses.
Over 20 other countries will take steps towards testing their own CBDCs in 2023. Australia, Thailand and Russia plan to continue pilot testing. India and Brazil plan to launch it in 2024.
In the United States, progress on retail CBDCs has stalled. The United States, however, is pursuing wholesale (bank-to-bank) CBDC. Why is the United States lagging behind other countries in developing a CBDC? Because the United States is concerned about the potential impact of CBDC on the banking system, and that it is also reluctant to give up control of the money supply.
Since Russia’s invasion of Ukraine and response to G7 sanctions, wholesale CBDC developments have doubled.
Benefits and risks of CBDC
Pros
- Improved Payment Efficiency and Accessibility: CBDCs can make payments faster, more efficient, and more accessible, especially for people who are currently unbanked or underbanked. This could be a major benefit for people in developing countries or rural areas.
- Enhanced Financial Inclusion and Access to Banking Services: CBDCs could provide a more secure and convenient way for people to store and access their money, which could help to reduce financial exclusion. This could be particularly beneficial for people in developing countries or those who are unfamiliar with traditional banking systems.
- Increased Security and Transparency: CBDCs could be more secure than traditional cash, as they would be protected by cryptography and blockchain technology. Additionally, CBDCs could provide greater transparency into the financial system, as all transactions would be recorded on a public ledger.
- Reduced Costs and Risks of Physical Cash Handling: CBDCs could reduce the costs and risks associated with the handling of physical cash, such as counterfeiting and theft. This could save banks and businesses money, as well as reduce the burden on law enforcement.
Cons
- Potential for Increased Surveillance: The use of CBDCs could increase government surveillance of financial transactions, as all transactions would be recorded on a public ledger. This could raise concerns about privacy and data protection.
- Potential for Disruption to Existing Financial Systems: The introduction of CBDCs could disrupt existing financial systems, as they could compete with traditional forms of money. This could lead to job losses and instability in the financial sector.
- Potential for Misuse: CBDCs could be misused for illicit activities, such as money laundering or terrorism financing. This could pose a threat to national security and financial stability.
- Lack of International Cooperation: The development and adoption of CBDCs could be hampered by a lack of international cooperation. This could lead to fragmentation of the global financial system.
Overall, the potential benefits of CBDCs are significant, but there are also some potential risks that need to be carefully considered.
Who will win this race: CBDC or cryptocurrency?
In conclusion, it is only a matter of time but, progressively, cash will be replaced by digital currency. What kind of digital currency? CBDC? Cryptocurrency? Who will win the digital payments race: CBDC or cryptocurrency? Both will probably coexist. It’s hard to speculate on this. We will see.