Although our world was becoming increasingly cashless with the advent of credit cards and online banking systems, the COVID-19 pandemic helped accelerate this transition towards a digital payment society. And it’s still gaining momentum. The major shift towards the use of digital money and the increased mass adoption of cryptocurrency and blockchain technology during the pandemic has resulted in Central Bank Digital Currencies (CBDCs) becoming an enormous topic of interest for governments around the world.

Currently, many countries are exploring how a Central Bank Digital Currency will impact their economies, financial systems, and stability.

But how does the introduction of digital dollars, euros, yuan, rupees, and many others affect the central banking system and the adoption of cryptocurrency?

In this article, we’ll answer the following questions:

  • What are Central Bank Digital Currencies?
  • How are CBDCs different from stablecoins?
  • What are the pros and cons of CBDCs?
central bank digital currency image

What are Central Bank Digital Currencies (CBDCs)?

Simply put, a CBDC is a country’s fiat currency, but in a digital format. A CBDC is issued, regulated, and fully backed by a country’s central bank or monetary authority, like the United States Federal Reserve. CBDCs run on centralized blockchains where governments maintain complete control of the network.

central bank digital currency map

According to the Atlantic Council, 91 countries accounting for more than 90% of the world’s economy are exploring or have explored CBDCs. What’s more, 9 countries have already launched one, including Nigeria and several Caribbean island nations.

In addition to these successful projects, many other countries are interested in CBDCs. For example, in February 2022, India announced its plans to introduce a digital rupee by the end of 2023, Jamaica piloted a successful CBDC program between August and December 2021, and even Sweden began developing the “e-krona” in response to the decline in the use of cash. These are but a few examples.

Countries like the United Kingdom, Canada, Australia, and even the United States are researching how CBDCs can improve their monetary systems.

MIT Research on CBDCs

Together with the Federal Reserve Bank of Boston (also known as the Boston Fed), researchers at the Massachusetts Institute of Technology (MIT) have begun to investigate the possibility of a CBDC in the U.S. 

Known as Project Hamilton, this initiative tested several factors needed to create a viable digital currency, such as transaction speed and volume, and the general resilience of the system.

The researchers developed two separate software systems for testing. One codebase (as the system is called) was able to handle 1.7 million transactions per second, whereas the other reached about 170,000 transactions per second. These numbers far exceed VISA’s 1,700 transactions per second.

MIT building CBDC research Massachusetts institute of technology

Despite the success of these initial tests, according to the Director of MIT’s Digital Currency Initiative, many questions remain about the viability of a CBDC, especially in terms of the policies governing it and its accessibility.

Around 36% of U.S. residents who do not have bank accounts do not have smartphones either, which is one of the several challenges of instituting a CBDC in the country. For this reason and many more, a cautious approach is needed to create a Central Bank Digital Currency.

How are CBDCs Different from Stablecoins?

As you’re reading this, you might be thinking that CBDCs sound quite similar to stablecoins. And, to a certain extent, you’d be right.

While CBDCs and stablecoins are both in theory pegged to the price of a real-world currency, such as the US dollar, there is a fundamental difference.

A stablecoin is issued by a private entity, whereas a CBDC is completely regulated and monitored by a nation’s government. In other words, a stablecoin aims to be more decentralized, which is one of the foundations of cryptocurrency, while a CBDC is, by definition, a centralized currency.

Note: Despite stablecoins being more decentralized than CBDCs, several are far from fully accomplishing this mission. Why? Many stablecoins, such as USDC and USDT, are completely owned and distributed by private companies (in this case, Circle* and Tether Limited), as opposed to a fully decentralized currency, like Bitcoin.

*Circle is connected to Coinbase and USDC is their collaboration

Now that you know what a Central Bank Digital Currency is and what makes it unique, let’s explore the potential benefits and disadvantages.

Pros of CBDCs

Increased Efficiency, Payment Speed, and Lower Fees

Put simply, CBDCs have the ability to increase efficiency and speed of payments. For example with peer-to-peer payments, such as sending money to a friend who lives in the same country as you after a dinner night, will be much faster than waiting for a traditional bank transfer to go through. All you’ll have to do is access your digital wallet to send them the digital dollars you owe them.

  • Cross-border payments will be settled instantly with minimal fees without the need for a traditional intermediary like Western Union, a bank, or other financial service providers. Reduced transaction costs would be a major step forward for a new currency that will replace cash.
  • Small and large businesses also stand to benefit from a digital dollar as they would likely represent lower fees for merchants. This is a great positive because it would help circumvent credit card processing fees, which can substantially eat into a company’s profits.

Better delivery of government payments

Government payments, such as COVID stimulus checks and welfare payments, would benefit from the Central Bank’s Digital Dollar since the payment delivery would be more efficient. For instance, throughout the COVID-19 pandemic, the United States government had a lot of difficulty in distributing their stimulus checks to citizens through the traditional banking system since they had to physically be sent by mail.

Having government-issued digital cash that you can access via an internet connection, be it on your smartphone or computer, could be an excellent way to work around these challenges.

A More Inclusive Financial System

CBDCs also stand to make the financial system more inclusive. The traditional system uses intermediaries like commercial banks, which fail to serve huge swathes of the population. This central authority leaves many people unbanked and with little or no access to financial services. This is not an enormous issue in more rich and powerful regions.

However, it is in some emerging and developing economies, where accessing cash or getting a bank account is a difficult and sometimes physically demanding task. For example, when people have to travel long distances just to access an ATM or branch of a bank. In sum, CBDCs cut out the commercial banks, allowing for more financial inclusion for more people.

Cons of CBDCs

Complete Government Control of Funds

Complete government control over an individual’s money can, in extreme circumstances (i.e. money being used to fund terrorism or other threats to national security, etc.), be a net positive for society.

However, for cryptocurrency enthusiasts, the thought of a government having complete control over a blockchain-based currency is the complete opposite of why cryptocurrency was created. (No, we’re not referring to or supporting tax evasion.)

With CBDCs, governments will be able to freeze central bank accounts, reverse transactions, and prevent people from spending their own money on things that the government and the government alone consider unacceptable.

For those looking for even more privacy, cryptocurrencies including Monero and Zcash can represent a viable way to hide their transactions from the public ledger.

Did you know: You can purchase both Monero and Zcash on Binance with your credit card! Go here.

Vulnerability to Cyber Attacks

Creating a centralized network run by a single entity (in this case, a central bank or government) concentrates massive amounts of financial data in one place. Therefore, if the network were to get hacked, it is a possibility that the attacker could potentially exploit this weakness, resulting in a total loss of funds for any CBDC holders. 

Same Inflation Risks as Fiat Currencies

Bitcoin, the first and most famous cryptocurrency, now serves a purpose as a deflationary store of value because it has a fixed and limited supply. In contrast, fiat currencies are by nature inflationary because they can be printed infinitely when more money is needed.

CBDCs, which are the digital counterparts of cash, would be no different. It would not counteract the impacts of inflation, such as the high levels we have witnessed since the beginning of the pandemic, which has reached 7.5%.

Exclusionary to Those Without an Internet Connection

CBDCs, like other blockchain-based currencies, have an initial barrier that many people often overlook. For the public to use CBDCs, they require access to an internet connection… and a smartphone, a computer, or another device that can connect to the web.

According to the United Nations, as of December 2021, nearly 3 billion people or 37% of the global population have never been online. Of those people, 96% of them live in developing countries.

This represents a severe disadvantage to the adoption of CBDCs. If so many people have never accessed the internet, it will be quite difficult, if not nearly impossible, for them to begin to use CBDCs.

buy sell cryptocurrency cbdc central bank digital currencies

Coin Clarity’s Thoughts on CBDCs

On one hand, CBDCs could represent an excellent way to expedite current monetary processes, especially with cutting costs and increasing efficiency. On the other hand, apart from being an online version, they appear to be very similar to fiat currencies, along with their inflation concerns.

Although they have not yet become mainstream, it’s quite possible that in the future many if not all governments will have their own CBDCs as a way to provide a “lite” version of cryptocurrency that they can exercise more control over.

However, despite the similarities in being digital currencies, unlike cryptos such as Bitcoin and Ethereum, CBDCs are not investments nor keys to unlocking decentralized finance. They are simply a digital extension of traditional money.

In the future, when and if they begin to be used in the real world, it’s likely that they will be used frequently as legal tender and as a replacement for physical cash.

The question then will not be whether people use CBDCs, but for what they will use them. Before mass adoption of CBDCs can fully arrive, though, the issue of security needs to be addressed.