#CBDCs: The Good, the Bad, and the Ugly. (2024)

In recent years, Central Bank Digital Currencies (CBDCs) have received a lot of attention. As digital currencies become more common, central banks around the world are investigating the potential benefits and risks of implementing their own digital currencies. Let's take a look at CBDCs, the good, the bad and the ugly...

First, what exactly are CBDCs?

CBDCs are digital currencies that are issued and backed by the central bank of a country. They serve as a digital representation of a country's fiat currency and are intended to be used in conjunction with physical cash. CBDCs are divided into two types: retail CBDCs, which are available to the general public, and wholesale CBDCs, which are only available to financial institutions and interbank settlements. If it sounds alarming that the public and financial institutions will have different money, well, hold that thought.

CBDCs: The Good

CBDCs may provide several advantages, including:

1. CBDCs, as digital currencies, can enable faster and more efficient transactions, lowering transaction costs and processing times.
2. CBDCs could also provide currently unbanked and underbanked populations with access to digital financial services. An estimated 4.5% of U.S. households (approximately 5.9 million) were “unbanked or underbanked” in 2021, meaning that no one in the household had a checking or savings account at a bank or credit union.
3. Monetary policy effectiveness could be improved if CBDCs provided central banks with more “precise” tools for implementing monetary policy, such as implementing regional negative interest rates to stimulate demand.
4. They could also reduce the costs and risks associated with managing and distributing physical cash. Though the Fed’s 2022 currency operating budget was $1.06 billion, which is largely and insignificant cost.

CBDCs: The Bad

CBDCs, despite their potential benefits, pose a number of risks and challenges:

1. Financial stability risks: CBDCs may prompt bank runs during times of financial stress, as individuals may quickly transfer deposits from commercial banks to CBDCs, undermining the banking system's stability.
2. Bank disintermediation: The widespread adoption of CBDCs may reduce commercial banks' role in the financial system, affecting their profitability and potentially limiting their ability to provide credit.
3. Implementing CBDCs would necessitate central banks addressing various technological challenges, such as cybersecurity, scalability, and interoperability with existing payment systems.

CBDCs: The Ugly

And now, onto the ugly side of CBDCs…

1. Privacy concerns: One of the primary concerns regarding CBDCs is the potential erosion of privacy. A centrally controlled digital currency system could allow governments and central banks to monitor all financial transactions, effectively eliminating the anonymity associated with cash transactions. This surveillance capacity could be exploited for political or social control, infringing on citizens' rights to privacy and financial autonomy.
2. Financial surveillance and control: With the ability to track every transaction, governments may be tempted to use CBDCs as a tool for financial surveillance, potentially enabling them to freeze or confiscate individuals' assets at will. This level of control raises concerns about the potential misuse of power and the potential for increased financial censorship. Moreover, such surveillance capabilities could be used to enforce compliance with government regulations and policies, potentially stifling innovation and restricting economic freedom.
3. Potential for misuse by authoritarian regimes: CBDCs could be exploited by authoritarian regimes to exert greater control over their populations. The ability to monitor and control financial transactions would allow these governments to suppress dissent, manipulate economic activity, and maintain a tighter grip on power. This potential misuse of CBDCs raises serious concerns about their impact on human rights and individual freedoms in countries with repressive governments.

Global Adoption of CBDCs

CBDC adoption varies greatly across countries, with some countries in advanced stages of development or pilot testing and others in the early stages of research and exploration.

Advanced stages of development and pilot testing: By 2021, 18 of the G20 countries had advanced stages of CBDC development, with 7 already in pilot testing. China is at the forefront of CBDC implementation among these countries. The Digital Currency Electronic Payment (DCEP) has already reached 260 million people through pilot programs, with plans to expand the initiative to the majority of the country by 2023. Other countries, including Australia, Thailand, Brazil, India, South Korea, and Russia, intend to continue or start pilot testing in 2023. The European Central Bank (ECB) is also expected to launch a pilot project in the near future.

Early stages of research and exploration: By December 2022, all G7 economies had advanced to the CBDC development stage. Project Cedar, the New York Federal Reserve's large-scale CBDC experiment, has moved the United States from research to development. In total, 114 countries, accounting for more than 95 percent of global GDP, are considering introducing a CBDC. This figure has risen dramatically since May 2020, when only 35 countries were considering a CBDC.

Eleven countries have fully launched digital currencies, with Jamaica being the most recent to do so with its CBDC, the JAM-DEX. These countries are part of a small but growing group of countries that have progressed from the exploration and pilot testing phases to actual implementation.

Cross-border CBDC projects: Financial sanctions against Russia have prompted countries to consider alternative payment systems to the dollar. As a result, the number of cross-border wholesale CBDC tests and cross-border retail projects has nearly doubled since 2021. These initiatives seek to improve the efficiency and security of cross-border transactions while decreasing reliance on traditional correspondent banking systems.

CBDCs vs. the Current System

CBDCs are distinct from the current monetary system in several ways:

1. CBDCs are digital currencies, whereas the current system is primarily based on physical cash and electronic bank deposits.
2. Retail CBDCs would be available to the general public, whereas wholesale CBDCs would only be available to financial institutions.
3. CBDCs are issued and backed by central banks, whereas commercial banks create the vast majority of electronic money in the current system.

And this leads us to the popular FedNow system...

FedNow isn't a CBDC.

FedNow is a Federal Reserve-developed instant payments system that enables real-time payments between financial institutions in the United States. FedNow is not a CBDC, despite its similarities to wholesale CBDCs. It is instead a payment rail or infrastructure designed to process transactions more efficiently, operating 24 hours a day, seven days a week, and allowing funds to be transferred without delay on weekends or holidays.

FedNow and CBDCs differ in several ways, including:

1. FedNow is a payment infrastructure, not a currency: Unlike CBDCs, which are a new type of digital currency, FedNow is a system for processing transactions that use existing currency.
2. FedNow operates within the existing monetary system: FedNow does not create new money, but rather improves transaction efficiency within the existing framework.

Faster payments are required in the United States, but FedNow is not the only option. FedNow was announced in 2019, but it took two years for the Clearing House (TCH) to launch the Real Time Payments (RTP) Network. Indeed, while not providing instant payments, simply increasing the operating hours of Fedwire and the National Settlement Service (NSS) to 24x7x365 would have improved the US financial system. Nonetheless, the Federal Reserve appears to have chosen to ignore the easier option and walk right over the private sector.

To put it in a nutshell...

CBDCs may have some benefits, but their drawbacks are considerable. While they can improve payment efficiency and provide central banks with new monetary policy tools, they raise severe concerns about financial privacy, surveillance and control, financial stability, cybersecurity, and commercial bank disintermediation.

Despite all of this, the adoption trend of CBDCs doesn't seem to be stopping anytime soon.

So what do you think…

CBDCs: good, bad, or ugly?