CBDC and the Future of Financial System
The cryptocurrency market is becoming a thriving trading market, where individual and institutional investors are continually increasing day in and day out. Even during the pandemic, the cryptocurrency market grew by more than 250% approximately. The crypto market has become a new flourishing investment option for almost everyone all over the world.
Now even this new investment option has been accepted by most Monetary governing bodies worldwide, such as The Office of the Comptroller of the Currency (OCC), The Federal Reserve System of many countries such as – USA, India, Japan, China, etc.… These governing bodies have even decided to issue their own digital currencies, called CDBC (Central Bank Digital Currency). While few countries are looking into the practicability of CBDCs, but no one has officially launched a centralized digital currency.
For years, the major central banks worldwide are studying digital currencies and have been analyzing it thoroughly. Therefore, now these central banks are considering the possibilities to spend on digital currencies.
A CBDC is a form of Digital Fiat Currency that uses a blockchain-based token, which represents the digital form of fiat money of a specific nation. This form of currency is centralized, and it is issued & regulated by the competent monetary authority of the concerned country. A central bank digital currency will predominantly use issued digital tokens and blockchain technology.
Unlike decentralized cryptocurrencies floating in the market such as Bitcoin, Ethereum, Litecoin, etc.… a central bank digital currency would be centralized and will be governed by a country’s monetary authority directly. Thus, CBDC issuing countries will have control and check over the digital currency issued by them.
Use Cases of CBDC
The emerging need for CBDCs has given the rise to the debate amongst the central bankers and policymakers of CBDC’s Use Cases due to the fear of the potential market risk carried by CBDC. Considering these aspects of CBDCs, it can be categorized as follows as per its utility or necessity:
Wholesale CBDC – It is mainly for financial institutions that hold reserve deposits with a central bank. It could be used to reduce liquidity risks and to improve efficiency in payments settlement. Wholesale CBDC is used to facilitate interbank settlement, i.e., payments between the few banks and other entities that have accounts at the central bank.
The daily volume of wholesale CBDC is usually less than 100,000 transactions. It is a value-based use case of CBDC; it means that when the sender transfer value, receiver will receive without any intermediaries at the time of the transaction. This process is actually different from the current traditional banking system. And CBDC has the potential to make existing financial systems quicker, inexpensive, and safe.
Retail CBDC – Retail CBDC is for the retailers. It has the features of anonymity, traceability, availability. Retail CBDCs can be used for payments between individuals and merchants, businesses.
The daily volume of retail CBDC can usually be greater than 100,000,000 transactions. It is more popular because it can improve economies, accelerate the implementation to cashless society, and reduce cash printing. A retail CBDC will be a new form of centralized digital money that is going to be governed by the central bank, and even its supply will be controlled by the concerned country’s monetary policy.
Advantage and Disadvantages of CBDC’s
CBDC has unique advantages, including improved financial access for retail customers and a more efficient interbank settlement infrastructure. Thus, the central banks and all the monetary authorities of the countries all over the world, who have been in the path of issuing their own CBDC’s such as The Bank of Japan, The European Central Bank (ECB), The Sveriges Riksbank, The Bank of Canada, The Swiss National Bank, and The Bank for International Settlements (BIS), Reserve Bank of Australia (RBA), International Monetary Fund (IMF), etc. should come together and analyze the pros and cons of this digital form of currency.
To have an overview of this aspect, the following are some advantages and disadvantages to be primarily considered while the issuance of the currency:
- CBDC’s are more secure, efficient, and technology wise advanced payment method or option than other existing cryptocurrencies in the market.
- CBDC’s could be available 24 /7 or only during certain specified times, such as the operating hours of large value payment systems.
- They could also be made available permanently or for a limited duration, i.e., on a customization basis as per need of the hour.
- CBDC’s will improve the overall effectiveness of the monetary policy when regulated and governed centrally, unlike other Cryptocurrencies.
- CBDC will improve the Financial Stability of the Crypto Market.
- They are a robust competition to the existing Fiat or Financial system.
- Cyber-threats, such as malware and fraud, are risks for nearly all payment modes, clearing, and settlement systems. However, they pose a notably more significant threat for CBDC, as it is total digitally based.
- The funding withdrawal and transfer of deposits are a few major drawbacks of CBDC’s to the banking sector.
- AML/CFT concerns and requirements are also the main drawbacks of CBDC’s that need to be tackled while considering its issuance.
A Central Bank Digital Currency is a digital form of traditional money backed by a central bank. The digital currencies could affect the role of central banks and lenders and also have the potential to change the face of the current monetary system.
However, on the other hand, CBDC’s once issued by the countries, will take the Banking & Financial system of the respective country to yet another level globally. Thus, after contemplating the pros and cons of the same, it can be said that CBDC’s issued, regulated, and governed by a central authority can be a boon to the economy of that country.