What is a Central Bank Digital Currency?
A CBDC is not a new form of currency but rather a digital representation of an existing national currency. For example, an Australian CBDC would hold the same value as an Australian dollar and be considered legal tender. It could be available in both retail and wholesale formats, but its use would remain optional, ensuring that physical cash remains in circulation.
Retail CBDCs would enable seamless transactions, including point-of-sale purchases, government payments, and peer-to-peer transfers. Most central banks are still deliberating on design aspects, with many suggesting that retail CBDCs won’t pay interest. Similar to physical banknotes, CBDCs would be issued by central banks and accessible via digital wallets on smartphones, fostering innovative financial transactions beyond traditional electronic money.
Wholesale CBDCs, on the other hand, would be restricted to financial institutions. They would function similarly to existing exchange settlement accounts held with central banks, streamlining interbank transactions.
Uses and Risks of CBDCs
CBDCs could help central banks maintain control over monetary policy, ensuring that central bank money remains relevant in an increasingly digital economy. They also have the potential to make cross-border payments faster and cheaper, which could be particularly beneficial for countries with high remittance inflows.
Furthermore, CBDCs could enhance financial inclusion in nations where large portions of the population remain unbanked. However, there are risks. A retail CBDC might lead to significant fund transfers from commercial banks to central banks, potentially destabilizing the banking system.
Another concern is anonymity. While CBDCs could offer cash-like anonymity, they might also raise privacy concerns if users are required to register to prevent illegal activities.
Smart Contracts and CBDCs
One of the most promising applications of CBDCs lies in smart contracts—self-executing agreements where payments are made instantly upon the fulfillment of predetermined conditions.
A vending machine is a simple analogy: when a customer inserts $2 and selects an item, the machine automatically dispenses it. Similarly, smart contracts could automate transactions for assets like shares and real estate, ensuring instant and secure ownership transfers.
Currently, stablecoins such as Tether and USDC are considered for smart contracts. However, their real-world use outside the crypto ecosystem remains limited. Even major financial players like the National Australia Bank and tech giants like Meta/Facebook have abandoned their stablecoin projects.
In contrast, CBDCs offer a reliable and government-backed alternative. As BIS Chief Economist Hyun Song Shin aptly stated, “Anything that crypto can do, CBDCs can do better.” Markelitics has echoed this sentiment, emphasizing that CBDCs could revolutionize financial ecosystems by enabling secure, efficient, and scalable digital transactions.
The Future of Digital Currencies
As central banks continue their research and pilot projects, the global financial landscape is gradually shifting. Whether CBDCs become the dominant form of money remains uncertain, but their potential to reshape financial systems is undeniable. With strong institutional backing and advanced technological capabilities, CBDCs may well be the cornerstone of a truly cashless society.
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