The Role of Digital Currencies in the Financial System

Central bank digital currencies are essentially a cryptocurrency issued by a government. This digital representation of the country’s fiat currency is designed to replace physical, fiat currencies.

The implementation of CBDC requires the issuing central bank to make several critical decisions. Perhaps the most crucial decision is whether the digital currency will be made available to the public at large to be used as a general-purpose currency. If the CBDC is not to be issued to the public, the issuing authority may decide to make it available only for use for settlement purposes between banks.

The Background of Central Bank Digital Currencies

The idea of CBDC’s is not new. The concept predated Bitcoin by over 20 years. Only in recent years has the idea gained traction. This prominence is mainly due to the many advances in the fintech arena, including blockchain technology.

The move towards digital currencies supports the “cashless society” trend. In Sweden, China, and South Korea, cash is rapidly becoming a redundant form of payment.

The Benefits of CBDC’s

Cryptocurrencies, Bitcoin for example, and CBDC’s have many comparable benefits. Conventional banks have defined hours of operation. CBDC’s can be available for transactions around the clock, seven days a week. To reduce their operating costs, banks could decrease their reliance on clearinghouses.

Like cryptocurrency, CBDC’s can be available to any owner of a smartphone. This alone would help people without convenient access to banks and ATMs.

There are benefits of using CBDC’s that go beyond the advantages offered by digital currency. It costs central banks money to print money. On average, it costs $.077 to print a single one-dollar bill. Digital currencies are not burdened with such costs.

Governments could find it considerably more manageable and less burdensome to distribute cash to citizens. The current coronavirus pandemic has led the U.S. government to provide citizens with Economic Impact Payments in the form of a check or debit card, both of which are prone to theft and fraudulent use. CBDC’s would allow for the direct issue of relief funds.

The Risks of CBDC’s

Although there are numerous benefits to CBDC’s, there are also considerable risks on the part of all participants, central banks, governments, and citizens.

Of all the risks, perhaps the biggest is cybersecurity. China has tested CBDC, only to have it hijacked by scammers. This is alarming. Currently, China is only testing the feasibility. The full version has yet to be launched. The risk of an attack on the network is real and is a concern for any central bank considering the launch of a CBDC.

Privacy is also a risk. Although the governments greater visibility into who is using a CBDC can reduce risk, it also opens opportunities for governments to overstep the boundaries of privacy.

Central Banks Have Yet to Issue a General CBDC

The use of some form of digital currency by central banks is ongoing, although none have yet issued any general CBDC. Several central banks are in various stages of development, including the USD, Euro, Yen, Pound Sterling, and the Yuan.

Earlier this year, a whitepaper was published which outlined the aims of the so-called “Digital Dollar.” Since May 2020, events have been making significant headway.

Less than a month ago, the Office of the Comptroller of the Currency gave every federally chartered bank the go-ahead to offer cryptocurrency custodial services. This move allows federally chartered banks to integrate crypto services.

The relief effort associated with COVID-19 is tending to act as a catalyst for the introduction of digital currency. A bill entitled “Cryptocurrency Act 2020” had been introduced. The bill attempts to clarify the regulation of digital currencies by federal government agencies.