• What are CBDCs?
• Why do they matter?
• What are the different types of CBDCs out there?
PwC Global Crypto Leader, Henri Arslanian immerses in the subject of сentral bank digital currencies answering all important questions.
A CBDC is a new and digitised form of central bank money, equal to physical cash or reserves that your commercial bank holds at the central bank.
But you may say that you already have digital cash – since everything you use, from your credit card to your favourite payment app to a basic bank transfer, involves using digital money.
Well not quite. Yes, those online transactions and payments are digital. But in reality, they are just debits and credits, or pluses and minuses, between different providers, like banks to payment companies.
Real central bank money is a component of the monetary base and a direct liability of the central bank. Today, that practically exists only in two forms: the first its physical cash that you hold in your hands and that you can see. The other, which you do not see, are the reserves that your bank holds at the central bank. CBDCs could constitute a third and new form of central bank money.
It is important to understand that there are two major types of CBDCs. The first is what we call wholesale CBDC, which would be used to facilitate payments only between banks and the central bank, or other entities that have accounts at the central bank itself. A lot of work has been done on this in recent years, from Canada and Singapore to Hong Kong and Thailand. While the development of wholesale CBDC is important, it does not affect you directly, as a member of the public. It relates more to the piping of the transfer of money between banks and central banks.
The second type of CBDC is what we call retail CBDC, which can be used by the public and businesses for everything from payments to saving. It very similar to bank notes today. And, this is a complicated topic, as it has numerous implications from financial stability to financial inclusion. For this reason, a lot of central banks and policy makers had pushed off exploring retail CBDC to the far off future.
But then Facebook’s Libra was announced in June 2019. That brought retail CBDC to the top of the agenda for all major policy makers and central banks around the world.
Over the last couple of months, there have been numerous papers or experiments done on retail CBDC from various countries, from the UK and China to the Bahamas and Cambodia. Furthermore, numerous global policymakers from the BIS and the FSB to the ECB and the FATF have published papers on this topic.
So you may wonder, what are central banks thinking when it comes to retail CBDC?
While central banks generally are not big fans of decentralised cryptocurrencies like bitcoin, as they cannot control the total supply as they do with traditional money, there are some features of bitcoin and cryptocurrencies that central banks love.
First, they allow for better monitoring and visibility of the economic activity in the country. Today, the central bank has no visibility on transactions made with cash. While this is great for businesses who are trying to avoid paying taxes, this is not great for the broader monetary and even fiscal policy of any country. With a CBDC, the central bank would be able to see, to a certain degree, all transactions carried out and thus be able to reduce financial risk.
Second, CBDCs offer a great fighting chance against money laundering. Today, a physical bank note represents the most private and anonymous method of payment, and it is not a surprise that it is still used a lot for illicit activities from drug and human trafficking to money laundering. A CBDC could, for the first time, give us a fighting chance against money laundering. It is a massive global problem. It is estimated that the amount of money laundered each year represents between 2-5% of global GDP, according to the United Nations.
Third, a CBDC can help with financial inclusion, especially in difficult times like we are going through with the coronavirus pandemic. As people shy away from using cash – worried that dollar bills and coins could carry the virus – two categories of people are negatively impacted.
First, the elderly, who tend to be less tech savvy when it comes to digital payments. And second, those who are unbanked, as they do not have a bank account or access to formal financial services.
As they do not have a bank account, many governments around the world are having trouble sending Covid-19 relief funds to the unbanked, despite the fact that they are often the people who need it the most. With a digital CBDC, money can be sent easily to everyone – for example to a digital app for a CBDC that can be installed in every single smartphone that allows the government to send out funds quickly and effectively. So, while they are not profitable enough clients for banks to bother opening them an account, technology today allows us to achieve some of the same benefits via a CBDC.
And, a blockchain-based CBDC allows numerous new possibilities that are not possible today, from having programmable money via smart contracts, to being able to do micro payments automatically in a connected world using the “Internet of Things”, or even to directly input monetary policy, like interest rates, directly on the CBDC.
While this is extremely exciting and truly shows the potential of the future of money, there are potential downsides as well, especially for traditional financial institutions.
First there is the risk of disintermediation of banks. If you replace your dollar banknote with a dollar CBDC, the impact is limited. But if the public start substituting their bank balances with CBDC, then this reduces the bank balances that banks hold, increases their funding cost, and reduces their profitability.
The bigger risk for central banks is that in the event of a crisis, a CBDC can accelerate a run on the banks. For example, today if you do not trust the banking system, you can go to an ATM and withdraw all your money in cash. However, there are physical limitations to how much you can withdraw from an ATM, let alone all the practical challenges with how you will secure and keep these banknotes safely. In a CBDC world, you could quickly remove your funds held at your bank and hold them in your digital wallet. And, unlike paper bank notes, there is no limit to how much you can store digitally.
Central banks (and your bank) are fully aware of this risk and this is why many CBDC initiatives have tried to put various restrictions, from a maximum amount of CBDC that someone is allowed to hold in their own CBDC wallet, to having a lower interest rate on CBDC than for bank deposits. Therefore, people have an incentive to keep their money in traditional banks.
The other concern is privacy. While allowing the central bank to see all transactions in a country is great for combating money laundering or corruption, it also raises privacy concerns.
So expect to see a lot of activity in this space over the coming months. The future of money has never been more exciting.