• Central Bank Digital Currencies Are on the Way, but So Are the Risks

  • For good reason, the development of central bank digital currencies (CBDCs) remains a hot topic of discussion.

    CBDCs, whether viewed as a solution or a threat to the global financial system, are where the world is looking for answers.

    Financial crimes and online-related fraudulent activities are on the rise. As a result, there is a need to safeguard the commercial mechanisms as a whole.

    Finding a solution to combat monetary and financial instability is included in this protection. Not only for countries, but also for individuals who are unable to obtain financial inclusion through banking institutions.

    The Bank for International Settlements reports that 56 central banks are currently researching or actively developing their own form of digital currency.

    The Bank for International Settlements (BIS) study backs up these findings. It was discovered in January 2020 that 80% of global central banking institutions are currently researching and developing a CBDC.

    In fact, the percentage of central banks performing proof-of-concept examinations is increasing, approaching 50%.

    Notably, 10% of the central banks polled intend to implement a broadly accessible retail CBDC within the next three years. Twenty percent intend to launch a retail CBDC within the next six years.

    The Advantages of Central Bank Digital Currency

    Concerns have been raised about CBDCs and the consequences of their implementation. However, there are some clear advantages to fully digitizing fiat currency.

    The possibility of accessibility is a significant advantage. CBDCs have the potential to increase access to digital currencies and financial services for those who have been financially excluded due to their circumstances.

    Immigration status, incarceration, prior defaults, limited financial knowledge, and, of course, poverty are examples of such factors.

    Furthermore, governments would be able to easily administer digital cash grants, especially during the next crisis.

    According to the World Bank, over 1.6 billion adults are “unbanked.” This refers to a person or entity who does not have access to a bank or other similar financial institution.

    This includes having no access to checking or savings accounts, as well as the digital money provided by mobile banking. This unbanked status extends to services such as insurance, loans, mortgages, and financial safeguards of any kind.

    Similarly, according to the Federal Deposit Insurance Corporation’s (FDIC) most recent National Survey of Unbanked and Underbanked Households, 14.1 million adults in the United States are unbanked.

    CBDCs could be a solution to the unbanked problem. They provide access without the constraints of a bank account. Rather, a person could gain access simply by downloading an app. This lowers the threshold for requiring a smartphone, which has become significantly less expensive in recent years.

    Another area where central bank digital currencies may be advantageous is in the world of decentralized finance. Rather than being viewed as a threat to the space, some see CBDCs as a stepping stone toward wider adoption of these tools and products.

    “CBDCs are a significant motivator for ordinary people to enter the new financial world of DeFi. People can continue to use their preferred fiat currency while also experiencing the magic of blockchain’s security, efficiency, and scalability,” explains Hsuan-Ting Chu, CEO and Co-Founder of Furucombo.

    “However, regulation is a critical step in allowing CBDCs to operate efficiently. That is how governments will set the rules for new entrants and “manage” those who are already there. The recent move by Uniswap has already shown us how a DeFi protocol should prepare for regulation.”

    China is at the fore.

    The issue of central bank digital currency regulation and government management is central to the debate over this digital currency.

    China leads the pack in terms of governments that have their eyes on the ball. In April 2020, China launched the most advanced project to date, a pilot project.

    Its central bank controls and regulates its version of digital currency, allowing the Chinese government to observe and monitor payments in real time, obviating anonymity by design.

    China has made several advancements with its “digital yuan” since its launch, distributing as part of various trials with an estimated $23 million of its digital currency currently in circulation.

    “In China, central bank digital currencies will become a reality very soon. They have already conducted pilot programs on their digital yuan and plan to launch their CBDC in 2022,” said Gunnar Jaerv, COO of First Digital Trust, a leading Hong Kong-based digital asset custodian.

    “When other countries realize the impact a CBDC can have on a country’s growth, we will see more acceptance of a central bank digital currency being rolled out in the future, but this will take some time. In the last ten years, China has already outpaced the rest of the world. They began with WeChat and AliPay and are now moving on to CBDCs.”

    The advancement of China’s digital yuan has piqued the interest of governments in other countries. This includes the administration of Joe Biden.

    The United States is keeping a close eye on its progress. This is due to concerns that a Chinese CBDC will be used to circumvent sanctions, undermining the US dollar’s superiority.

    The institutional interest is growing.

    International communities such as Japan, France, and Australia are among the growing list of countries attempting to develop a CBDC initiative.

    Russia, for example, recently announced a plan to test a digital ruble by 2022. In addition, the Boston Fed is working with the Massachusetts Institute of Technology to create a CBDC.

    The Central Bank of Nigeria recently announced plans to begin a CBDC trial codenamed “GIANT” on October 1. The open-source blockchain Hyperledger Fabric will power the digital currency.

    The Monetary Authority of Singapore (MAS) has requested financial technology firms to submit proposals for a retail model CBDC infrastructure.

    The benefits and drawbacks of central bank digital currencies

    However, just because there is interest and potential benefits does not mean there aren’t risks and concerns.

    Concerns include the possibility that CBDCs will exacerbate the world’s most difficult financial issues. Rather than being the intended solution.

    According to a Fitch Ratings Agency report for 2021, “widespread adoption of CBDCs may disrupt financial systems” if associated risks are not managed.

    These dangers include cybersecurity threats, which are becoming more prevalent as more of the world’s population goes online. Concerns about financial disintermediation were also raised.

    Another threat associated with CBDCs is the controls required to avoid bank runs and supply issues. Currently, fiat currencies are somewhat controlled by printing supply. When a currency is digital, however, this is not a limitation.

    While central banks do have some control over currency circulation and supply. Another risk vector is whether they will adequately transition this into the digital space.

    The importance of privacy as a central issue

    In addition to this control, there is the overarching concern of privacy. According to a market study conducted by the Official Monetary and Financial Institutions Forum (OMFIF) on the essential components of a CBDC, privacy and security are the primary concerns.

    In the United States and Germany, 70% of respondents were more concerned about privacy as a fundamental component of a presumptive CBDC.

    Because a CBDC will make it easier for governments to view and track transactions, privacy is a major concern.

    Most government agencies already have access to financial records when consumers use banks. However, this can only be done by carrying out a court-ordered warrant.

    While digital currencies can help the unbanked, they can also be used by governments to increase centralization.

    Despite the fact that a national currency is a standard, there is a market in which consumers can choose which banking apparatus they use. They can select their bank, modify the terms, and maintain some level of control.

    There is concern that digital currencies issued by central banks will consolidate this control. As a result, citizens’ ability to maintain greater financial autonomy is hampered.

    The Bitcoin conundrum

    This is where the CBDC vs. cryptocurrency debate frequently arises. Bitcoin and other cryptocurrencies were created with privacy and self-sufficiency in mind.

    These creators want to free users from government financial surveillance, control, and central bank policies.

    Many cryptocurrency traders believe that these elements are the lifeblood that has fueled corruption and inflation.

    In his 2008 white paper, Satoshi Nakamoto writes, “What is required is an electronic payment system based on cryptographic proof rather than trust.” “Transactions that are computationally impractical to reverse would safeguard sellers against fraud.”

    Some, however, do not believe it is not a zero-sum game. According to Meltem Demiorors, CoinShares’ chief strategy officer, a CBDC “is structurally no different than fiat, and they are very much complementary to crypto, not competitive.”

    CBDCs are unavoidable. Our world is going digital, and the need for a paper-based monetary system is quickly becoming obsolete. The risks and rewards of a digital national currency will become clear over the next few years.

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