Knowledge Base: Central Banks, Financial Inclusion, Monetary Policy, Digitalization
The CBDC Series – Part 2 : Understanding Central Bank Digital Currencies
For investors, understanding CBDCs is essential, as they are already influencing financial markets, from cryptocurrencies to government bonds. In this second article of our series on CBDCs, we will explore the basics of this monetary revolution and its impact on financial markets.
Understanding CBDCs is crucial, as they are already influencing financial markets, from cryptocurrencies to government bonds. Unlike cryptocurrencies, CBDCs are government-backed and have the same value as physical currency. Moreover, they will become a tool of monetary policy to stabilize, control growth, and manage inflation.
More Than Just Digitization
CBDCs represent a major evolution, going far beyond the simple digitization of money. They introduce a new variable into the monetary equation and money supply. They are the manifestation of fiat currency in digital form, issued and regulated by central banks. The fundamental objective of a CBDC is to provide a new form of money that possesses all the characteristics of physical cash.
CBDCs can be broadly categorized into two types:
Retail CBDCs: Accessible to the general public, these are intended for general use or retail transactions (CBDC-R). Potentially available to everyone, including the private sector, non-financial consumers, and businesses, they aim to replace or complement cash in everyday transactions.
Wholesale CBDCs: Designed for financial institutions, these are for wholesale transactions (CBDC-W). Access is limited to financial institutions. CBDC-W facilitates interbank transfers and other wholesale transactions, optimizing settlements and market operations
CBDCs can be structured in two ways: token-based or account-based. Token-based systems function like physical cash, where possession equals ownership. Account-based systems, like bank accounts, require identity verification and transaction records. While token-based CBDCs might be preferred for retail use (CBDC-R) due to their similarity to physical cash, account-based systems could be more suitable for wholesale applications (CBDC-W)
A Global Shift Towards CBDCs
CBDCs are designed for security and efficiency, offering faster and cheaper payments compared to traditional methods. They also have the potential to improve financial inclusion by providing access to banking for unbanked and underbanked populations. Indeed, developing countries like Jamaica, the Bahamas, Ghana, and Nigeria were among the first to launch CBDCs, starting as early as 2020.
Since then, the momentum behind CBDCs has become a global phenomenon. Countries worldwide,
from emerging economies to the most advanced nations, are actively exploring this technology. According to CBDC Tracker statistics, 130 countries are currently or have already researched CBDCs. Seventeen countries are in an advanced pilot phase, with major economies like India, France, Canada, Singapore, and Saudi Arabia included in this list.
China and Russia are at the forefront, having already launched their e-yuan and digital ruble, respectively, illustrating their ambition to combine technological innovation with international monetary influence.
Africa is also demonstrating a strong interest in CBDCs, seeing them as an opportunity to promote financial inclusion and modernize payment systems. Eleven sub-Saharan African countries are exploring the use of CBDCs to enhance payment systems and financial integration.
Number of countries worldwide that are involved in the development of a central bank digital currency (CBDC) from 2017 to 2024
Last updated November 2024
Motivations Driving CBDCs Central banks are pursuing several key objectives with CBDCs:
Maintaining Monetary Sovereignty: To retain control over currency creation and management in the face of rising private cryptocurrencies.
Modernizing Payment Systems: To offer faster, more secure, and cost-effective transactions.
Promoting Financial Inclusion: To provide access to financial services for unbanked populations.
Combating Financial Crime: To leverage the traceability of digital transactions to fight money laundering and terrorism financing.
Strengthening International Monetary Position: To avoid being disadvantaged in global trade within the digital age.
Challenges and Implications of CBDCs
The adoption of CBDCs raises critical issues:
Privacy Protection: Balancing transparency with the need for privacy is a major concern.
Financial Stability: The impact of CBDCs on commercial banks and the overall financial system requires careful evaluation.
Cybersecurity: Robust protection against cyberattacks is essential for ensuring trust in CBDCs.
Digital Divide: Addressing how to effectively provide services to populations with limited digital literacy.
CBDC - An Interest-Bearing Instrument?
A key question arises: will CBDC holdings earn interest? It's crucial to remember that CBDCs are designed as an alternative to physical cash. Just as storing cash doesn't generate income, neither should basic CBDC holdings.
Just like holding cash, storing CBDCs does not inherently generate income, unlike depositing money in a bank account. When a consumer deposits funds into a bank account, they are essentially lending money to the bank for its operations, and in return, the bank pays interest. In the case of CBDCs, the funds are issued by the central bank, which does not allow mass account openings by ordinary citizens.
Allowing consumers to hold accounts directly with the central bank could undermine the role of commercial banks, potentially destabilizing the economic structure of a nation. Commercial banks play a critical role in lending and credit creation, and bypassing them could disrupt the financial ecosystem.
However, the question of whether CBDCs should bear interest remains open. Some argue that offering interest on CBDCs could make them more attractive as a savings tool, especially in a low-interest-rate environment. Others caution that this could lead to excessive shifts of funds from commercial banks to central banks, weakening the banking sector.
Conclusion: A Future in the Making
CBDCs represent a profound transformation of monetary and financial systems. Inspired by cryptocurrencies and blockchain technology, they aim to enhance financial stability, improve transaction security, and promote financial inclusion. However, their widespread adoption is not yet guaranteed, especially in countries where cash remains dominant.
To succeed, governments and central banks will need to address several challenges: raising public awareness, modernizing infrastructure, and establishing a robust regulatory framework. CBDCs pave the way for a more inclusive and innovative financial era, but their success will depend on our ability to overcome technical, social, and regulatory obstacles.
The future of money is in the making, and CBDCs are one of its cornerstones.
Market size of central bank digital currency (CBDC) worldwide in 2023, with a forecast for 2030 (in million U.S. dollars)
Disclaimer Please note that articles may contain technical language. For this reason, they may not be suitable for readers without professional investment experience. Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may make different investment decisions for different clients. This article does not constitute investment advice. It is provided for information purposes only and does not constitute an invitation to invest. Please seek advice from your investment advisor before investing.
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