Bitcoin is the star of virtual currencies in this period, but central banks are trying to reduce the attraction for cryptocurrencies by developing their own digital currencies, the so-called CBDCs. These are not currently widely used.
According to PwC, more than 60 central banks are actively exploring or developing CBDCs. And “CBDC’s introductory efforts are gaining momentum,” according to a report by Morgan Stanley.
Bank of China, the most advanced program
China is the most advanced in this regard, having launched pilot programs for a digital yuan, or renminbi, in several cities.
The European Central Bank has recently completed a period of public consultation on a possible digital euro. ECB President Christine Lagarde said in late March that the ECB’s governing board would decide to advance the idea of a digital euro in mid-2021. She added that the launch could take another four years.
CBDC, alternative to Bitcoin?
A CBDC is essentially a digital version of a traditional currency. It could be used instead of checks, banknotes or other forms of money. Consumers or companies could hold CBDC deposits directly with a central bank, trading through an application or other payment system.
The race for CBDC development is driven by several trends. One is the meteoric rise of Bitcoin and other cryptocurrencies. There are thousands of virtual currencies in circulation, driven by the popularity of Bitcoin. Their total market is worth about $ 2.2 trillion, with Bitcoin holding about half of it.
Central banks, hampered by Bitcoin
The rise of cryptocurrencies puts central banks and financial authorities to the test. Transactions in alternative currencies are not as easy to track as those that run through banks and other traditional intermediaries. Central banks are worried about losing control of monetary systems, maintaining control over cash in circulation and implementing monetary policies, such as negative interest rates, which could be much less effective if more people own and trade in cryptocurrencies, rather than standard money.
Cryptocurrencies can also undermine countries ’capital controls, such as blocking currency outflows or suspending access to bank deposits during a financial crisis, as cryptos operates in an alternative financial system. Turkey, for example, has recently seen its pound fall by 12% and has had to calm markets, fearing it will impose new restrictions on its currency’s foreign exchange. The country’s central bank recently banned the use of cryptocurrencies for transactions in goods or services.
“If you’re a central banker today and you love Bitcoin, you’re crazy,” Henri Arslanian, global crypto leader at PwC, said in a Citi report. “It’s like the taxi driver was thrilled to see Uber enter their market.”
What can CBDC do?
CBDC differs from cryptos in several key ways. First, the CBDC would increase or decrease in value with its base currency, just like cash. And the supply would not be limited, because central banks can print as much money as they want, downloading it in paper money, digital tokens or entries in a financial register.
Bitcoin and most cryptocurrencies are not related to anything tangible. They are hosted on large registers or blockchains, and their deliveries can be systemically constrained – in the case of Bitcoin, to 21 million chips. As a result, people hold cryptocurrencies such as Bitcoin as a hedge against “fiat” currencies that lose their value through inflation and the increase in the money supply, known as currency degradation. Fiat money is a currency issued by the government, which is not supported by a physical commodity, such as gold or silver, but rather by the government that issued it.
But CBDCs could erode some of the attraction for cryptocurrencies. For example, CBDCs could be exchanged instantly, 24 hours a day, for 7 days a week. They could replace cash in the banking system, attracting people who do not have bank accounts.
Transaction costs could also be lower, as CBDCs could eliminate commercial banks or other intermediaries. And it could quickly gain traction for international remittances. About 250 million people send more than $ 500 billion in cross-border remittances annually, paying an average fee of 7%, according to Arslanian.
The CBDC also uses central banks as a means of tracking money in circulation. Payment applications in China, such as Alipay and WeChat, are now widely used instead of cash, creating new barriers for authorities to track and monitor transactions. Financial authorities also fear that applications from companies such as PayPal Holdings and Square facilitate the transaction in cryptocurrencies. Black market activities, such as money laundering and tax evasion, are already difficult to track with cash and the cryptographic world is only complicating it.
“The reality is that CBDCs give us a chance to fight money laundering and illicit activities,” Arslanian said.
CBDC is still waiting
A major CBDC used in global trade is unlikely to appear any time soon. Political and technological obstacles will probably take years to overcome. The confidentiality of a CBDC – or lack thereof – could also slow adoption. Moreover, their use as a legal means of payment is debatable, because a CBDC is based on an account or token, according to the International Monetary Fund.
So far, the “sand dollar” in the Bahamas and Bakong, a CBDC launched by Cambodia’s central bank in November, are the only ones used outside of China.
But China’s digital yuan could pave the way for an explosion in the CBDC in the next few years. According to PwC, digital transactions in yuan worth about $ 300 million took place in Asia. The Chinese government is expected to try to push it into wider circulation in time for the Beijing 2022 Winter Olympics.
While cryptocurrencies and CBDCs can coexist, commercial banks may face stiffer competition for deposits and transaction fees.
“Commercial banks will face the risk of disintermediation,” Morgan Stanley said in a report. Consumers could transfer their bank deposits to CBDC accounts, eliminating commercial banks, and people could easily use payment applications for transactions. “These factors will increase competitive pressures on commercial banks,” says Morgan Stanley.
Banks will have to find a way into the CBDC system to avoid eliminating the new world of digital money.