The CBDC Disruption

Central Bank Digital Currencies (CBDCs) could prove to be the biggest disruptor to global finance yet — is the world ready for it, though?

Flanked by increasing global recognition and technological windfall, the Central Bank-backed Digital Currency (CBDC), may indeed just turn out to be the biggest innovation to come into banking since the invention of the ATM machine. Over 50 global monetary authorities, including several of the world’s major global central banks such as the Federal Reserve in the United States and the European Central Bank are now treading, albeit lightly, the tepid waters of the CBDC bandwagon. This follows the pilot scheme already undertaken by the Chinese, who have rolled out an electronic currency (the e-Yuan) to over 500,000 of its residents.

The Recentralisation of Finance

CBDCs, or ‘govcoins’, as The Economist calls it, would essentially be a centralised payments medium that would initially run simultaneously along with fiat currencies (paper money and coinage) and decentralised payment means (such as Venmo or Paytm). Essentially, it works by eliminating the middleman – in this case, retail banks – to allow one to make a deposit directly with the central bank issuing the currency.

One major difference in the way CBDCs would function as opposed to current means of payment is through the use of distributed ledger technologies (DLT) wherein a hybrid architecture of existing payment means could potentially couple DLTs for increased transparency and fund tracing. The money would thus, in effect, be an efficient means of payment, a stable unit of account, and backed by the state itself instead of a fallible bank: conversely, for you to lose your money, the entire state machinery would have to collapse.

Whilst this may be appealing to many, such as those suffering from the bankruptcy of several major banks during the Global Financial Crisis of 2007/08, the primary agenda behind the adoption of CBDCs is the (re)centralisation of finance, where central banks (read: governments) would now be able to track all transactions being carried out in their digital currency through private blockchains (as opposed to the public blockchains used by most cryptocurrencies worldwide).

The Ramifications of Disruption

The Economist opines, “If payments, deposits and loans migrate from banks into privately run digital realms, central banks will struggle to manage the economic cycle and inject funds into the system during a crisis. Unsupervised private networks could become a Wild West of fraud and privacy abuses.”

CBDCs, in this regard, would be state-backed, universal and cheap – and would even majorly cut operating costs of the global financial industry. This, many opine, could even allow for the proliferation of finance to the 1.7 billion people who currently lack any sort of formalised banking services. Additionally, it would expand governments’ toolkits, allowing them to make instant cash injections to citizens, levy e-fines for and even cut interest rates below zero.

In spite of the several positives, certain other aspects need to be considered as well: such as the fact that if unconstrained govcoins were to enter the market and network effects were to make opting out difficult, retail banks could face the fear of destabilisation. Lenders would then have to find other sources to finance their loans, thereby handing much greater power to bureaucrats in controlling credit allocation.

Another major ramification, of course, could be the potential destabilisation of the US Dollar. As The Economist reports: “(CBDCs) could alter geopolitics, too, by providing a conduit for cross-border payments and alternatives to the dollar, the world’s reserve currency and a linchpin of American influence. The greenback’s reign is based partly on America’s open capital markets and property rights, which China cannot rival. But it also relies on old payments systems, invoicing conventions and inertia—making it ripe for disruption. Small countries fear that, instead of using local money, people might switch to foreign e-currencies, causing chaos at home.”

However, in spite of this, a global framework of CBDC interoperability could make cross-border payments much simpler than the current paradigm of SWIFT payments. Instead of travelling through a maze of financial contingencies, CBDCs could increase efficiency, improve authentication and reduce transaction costs drastically.

As it stands today, several global central banks, such as the US Federal Reserve, the European Central Bank, and even the Indian RBI have all taken a rather cautious stance on CBDC adoption and implementation. With increasing bans on cryptocurrency transactions in China and majorly fluctuating cryptocurrency prices, CBDCs may indeed turn out to be the major turning point in digital payment means for the years to come.