What is a CBDC, and which countries are testing CBDC?

Central bank digital currencies (#cbdcs) are a hot topic in the financial world. Banks, institutions, FinTech's, and governments are researching and analysing the economic and technical feasibility of introducing a new type of digital currency, as well as the impact on monetary, fiscal policy, and the public.

According to a Bank of International Settlements report, more than 80% of central banks are already exploring CBDC. It begs the question, why are these institutions so interested in CBDCs??

Why do Governments issue a CBDC?

The most obvious and immediate benefit of a CBDC is faster, cheaper, and more efficient payments, domestically and internationally. It would also reduce the costs of making, distributing, and safeguarding physical money. These gains can deliver greater productivity in an economy, a fundamental aspect of economic development. Additionally, Cash has proven to do some serious damage lately, and it’s not enablement of finality and transparency.?

If a country issues a CBDC, the government will regard it as legal tender, just like fiat currencies; both CBDC and physical cash would be legally recognized as a form of payment and act as a claim on the central bank or government. If a country wants to transition to a cashless society, a digital currency backed by the government or central bank is the first step toward it. As the market for private e-money grows, governments are under increasing pressure to implement a CBDC. Why so? CBDCs are a sovereign option as compared to other less safe digital instruments, which may lead to less reliable payments, a relatively volatile store of value, and potentially erode monetary and financial stability.??

The private market has not waited to leverage the benefits of the underlying technologies surrounding a government-backed CBDC. Take Circle and UNDC as an example-

Circle Internet Financials reserve assets for USD coins (USDC) show $42.1 billion in short-term U.S. government bonds and $13.6 billion in cash. Circle also held $13.6 billion in cash at U.S.-regulated financial institutions, the Bank of New York Mellon, Citizens Trust Bank, Customers Bank, New York Community Bank, Signature Bank, Silicon Valley Bank, Silvergate Bank, and U.S. Bancorp. The $55.7 billion in assets Circle shares is slightly higher than the 55.4 billion USDC tokens in circulation. USDC is supposed to hold a 1:1 peg to the U.S. dollar.

Beneficiaries will be disadvantaged if it becomes widespread because e-money providers seek to maximize their profits rather than the general public's.

Although these are still early days for CBDCs, we don’t quite know how far and how fast they will go.? We know that central banks are building capacity to harness new technologies—to be ready for what may lie ahead.

The issuance of a CBDC would give governments an advantage over private e-money competitors. If CBDCs are designed prudently, they can offer more resilience, safety, availability, and lower costs than private forms of digital money. That is the case compared to unbacked crypto assets that are inherently volatile, giving governments a distinctive edge over private crypto insurers.

In addition to domestic transactions, the current cross-jurisdiction payment model is heavily reliant on central banks operating the real-time gross settlement (RTGS) infrastructure, within which all obligations of local banks must settle. It's also interesting to look at the newly swift and other payments coming in with propositions against CBDC or crypto, including SPFS, CIPS, BESPOKE, etc. While we all agree that there are time lags in cross-border payments, participants are exposed to settlement and credit risk. A CBDC is available 24 hours a day, seven days a week, and gives society a chance to take privacy seriously and find new paths to eliminate counterparty credit risk.

Different types of CBDCs

CBDCs are categorized broadly into two different proposals based on the targeted users:

Retail Central Bank Digital Currency.

Retail CBDC, based on distributed ledger technology, is traceable, anonymous, and available around the clock. It offers possibilities for interest rate applications, as well. Retail CBDC allows governments to know exactly who owns which numbered CBDC! This is ultimate surveillance and allows the government to "burn" your CBDCs if they want to. Therefore a Wholesale solution puts the banks in between to safeguard privacy better.

Wholesale Central Bank Digital Currency

Wholesale CBDCs are intended to settle interbank transfers and related wholesale transactions, resolving liquidity and counterparty risk issues. It’s a great fit for financial institutions with reserves deposited in a central bank. With their capability to improve wholesale financial systems' speed and security, even central banks consider wholesale central bank digital currency a favoured alternative to existing systems today.

Countries experimenting with CBDCs

• China | Digital Yuan

People's Bank of China was one of the first central banks to create a CBDC. The digital RMB is legal tender and has equivalent value to other forms of the renminbi, also known as the Chinese yuan (CNY). In 2014, they formed a special task force to research and implement a digital Yuan. It gained traction when China announced the testing of a CBDC prototype in 2020. The first digital Yuan trial will take place in Shenzhen's Luohu district in October 2020. The second pilot program was held in Suzhou City in early 2021. Consider this, more than 20.8 million people are currently using a digital RMB wallet in China, and they have made over 70.7 million transactions totaling 34.5 billion RMB ($5.3 billion). According to reports, the Chinese digital Yuan will impact China's $27 trillion payment market.?

• Marshall Islands | Sovereign

The Republic of the Marshall Islands announced plans to launch a CBDC called Sovereign (SOV) in 2018. The US dollar is currently legal tender on the island, owing to its small population of over 58,000 people and the high cost of printing cash. RMI intends to use SOV as an alternative digital currency as legal tender to improve the efficiency of RMI's current payment systems.

• Sweden | e-krona

The world's oldest bank, Swedish Riksbank, launched its CBDC project called e-krona in 2017. A pilot was conducted in collaboration with Accenture PLC from 2020 to February 2021, and the project was extended until February 2022. E-krona intends to provide a strong alternative in the event of an emergency or turmoil among private payment service providers, ensuring the stability of the Swedish payment system.

• Sand Dollar | Bahamas

Issued by the Central Bank of The Bahamas in October 2020, the Sand Dollar is a digital iteration of the Bahamian Dollar. The initiative began in two districts: Exuma and Abaco Islands; each Sand Dollar is a digital variant of the Bahamanian dollar, pegged to the US dollar at 1:1. The project provides everyone with equal access to financial services and regulated payments.

• Eastern Caribbean Area | DXCD

The Eastern Caribbean Central Bank, the monetary authority for the Organization of Eastern Caribbean States members, began work on a CBDC project called DXCD to reach financially excluded segments of the population. Its prototype is being tested in Antigua and Barbuda, Grenada, Saint Lucia, St. Kitts, Nevis, and St. Kitts and Nevis. DXCD's primary goal is to be a low-cost retail payment system for citizens without credit cards and merchant and e-commerce payments.

The effort and attention that central banks are committing to central bank digital currencies promises they will become a reality shortly. Introducing CBDCs into the world will help boost crypto adoption by providing people access to platforms for converting cryptocurrencies into legal tender. Furthermore, it will aid in the financial inclusion of the unbanked population.

CBDCs will have far-reaching consequences for the future of finance, including purchasing and selling digital assets and securities. But the question is, when? This response will rely on the foundations of a dedicated legal framework to facilitate global governments' transparency, distribution, and issuance of a digital form of money. As regulators and central banks take concrete steps toward establishing CBDCs, the rest of the world will begin to accept digital currencies as a standard.

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