Every day the world becomes more digital, hence the growing interest of central banks in digital versions of paper money.
CBDCs have the potential to help modernize payments and bring more people into the digital economy
Bogota DC August 2021. Where does the cash come from? The central bank of your country, such as the US Federal Reserve or the Bank of Japan, or in our case the Bank of the Republic: authorizes the printing of paper bills that arrive in your wallet. Here’s what’s happening: Today, fewer people carry cash, if we even have a physical wallet. We pay with cards and digital buy dogecoin wallets.
As the world becomes more digital, central banks are researching, and in some cases already launching or testing, their own digital versions of paper money, called central bank digital currencies, or CBDCs.
In most cases, they are designed to be used in the same way as cash, to buy and sell goods and services, and like cash, they are backed by the central bank of each country. CBDCs have the potential to help modernize payments and bring more people into the digital economy. Here’s how CBDCs work and what they mean for consumers:
Why are countries increasingly interested in issuing their own digital money?
In an always-on world, some central banks still rely on outdated technology that doesn’t allow for 24/7 payment processing. Some countries are upgrading their banking infrastructure to enable real-time payments, but CBDCs are another way to modernize payment infrastructure, enabling faster transactions during more hours of the day.
CBDCs also offer a way to reduce the inefficiencies of printing and moving money: the cost of managing physical cash can be as high as 1.5% of a country’s GDP. As connectivity increases and smartphones proliferate, CBDCs could also be a way to include more people in the digital economy who currently do not have access to basic financial services.
Are CBDCs like private cryptocurrencies?
CBDCs and private cryptocurrencies that often make the news, such as Bitcoin and Ether, are digital currencies with no physical counterparts. But CBDCs are issued by a central bank, with the same guarantees that back a nation’s paper money: they are equivalent to cash and designed for everyday transactions. Private cryptocurrencies, by comparison, are not backed by a government. The most popular cryptocurrencies are free-floating, meaning their prices are determined by the market. That makes them much more volatile than traditional money. They have been used more as investment vehicles than actual currency for day-to-day trading, although there is a growing acceptance of cryptocurrencies among merchants and new options such as “crypto cards”, Convert your cryptocurrencies into fiat currency at places that accept traditional credit cards.
One private cryptocurrency that has significant activity is stable coins, which are designed to have a constant value. These tokens are much closer to CBDCs than their free-floating counterparts, although they also lack the formal backing of a central bank. To ensure financial sovereignty and stability, some governments see the development of their own digital currencies as a necessary project to keep up with new fintech concepts like stable coins.
How quickly will CBDCs take off?
Nearly nine in 10 central banks are actively exploring CBCDs in some form, with central banks in countries representing a fifth of the world’s population saying they are likely to issue a CBDC in the next three years, according to a survey of 2021 carried out by the Bank for International Settlements (BIS).
So far, only the Bahamas has formally launched its CBDC, after a few months of Hurricane Dorian, it piloted its own digital currency called the Sand Dollar on the Exuma and Abacos island chains, becoming the first country in the world to offer a CBDC nationwide. Additionally, created a Mastercard strategic alliance to issue the first prepaid card linked to a CBDC, which offers residents the option to instantly convert their sand dollars into Bahamian dollars to spend anywhere Mastercard is accepted on the islands and throughout the world.
For its part, China is actively testing its digital yuan. But widespread implementation is unlikely in the short term, according to the BIS, as there are many technical challenges to overcome, and central banks considering CBDCs may need authorization from their legislative bodies to issue them. Additionally, central banks will seek to coordinate international policies and standards for CBDCs. Suffice to say, there is much more work to be done here.
Will CBDCs Replace Paper Money?
They possibly could, but it’s unlikely. After all, barter continues to exist thousands of years after the introduction of physical currency. Although digital transactions have been on the rise, and the shift to contactless transactions has accelerated during the pandemic, cash remains the most popular medium of exchange around the world, especially in developing markets. For example, 96% of total transactions in Indonesia are in cash, according to McKinsey. Most central banks have said they are committed to issuing and distributing physical cash whenever there is demand. But just as cards, real-time payments, and, more recently, digital wallets have given people more choice and security, CBDCs could as well.
How would paying with a CBDC actually work?
CBDC designs vary, but one made to fit today’s payment infrastructure would work much like a mobile wallet. A central bank could issue the digital money to financial institutions for distribution, or even directly to your digital wallet, much like a direct deposit of a government welfare benefit or stimulus payment.