CBDC – CENTRAL BANK DIGITAL CURRENCIES
Most of the world’s central banks are now looking quite intensively at the possibility of introducing their own digital currencies. They are responding both to the growing interest in cryptocurrencies and the diminishing potential of current monetary stimuli.
What does the abbreviation ‘CBDC’ stand for?
And what would the emergence of an alternative to today’s cash and electronic money mean for the financial system?
To understand the importance of Central Bank Digital Currencies (CBDC), we first need to understand how today’s money works. It can be held in cash, which represents a liability of the central bank. The other—now more commonly used—option is electronic money in the form of bank deposits, which is then a liability of a specific commercial bank.
If CBDC were to be introduced, there would be the possibility of holding money that is a liability of the central bank in electronic form. This would remove the counterparty (commercial bank) risk that exists with current electronic money. However, central bank digital currencies would be fully convertible into other types of money at a 1:1 ratio, and would thus be an alternative to cash or bank deposits from the user’s perspective.
The main benefits of CBDC touted by central banks are that they can speed up payments while making them cheaper, and they can make the financial system more resilient. However, an ordinary user would not perceive any significant improvements. Rather, the introduction of digital currencies would untie the hands of central banks in the area of monetary policy—and all the more so if cash, which is currently the closest thing to CBDC, was abolished over time.
The central banks would then be in a much better position to manage the volume of the money supply in the economy, something they now only indirectly control. It could also remove the constraint on negative interest rates, currently prevented by the alternative of holding money in cash. The CBDC would also open a Pandora’s box in the form of the possibility of introducing a helicopter money policy, i.e. distributing monetary stimulus to the population directly from the pocket of the central bank.
Transactions made through central bank digital currencies would be highly traceable, making tax evasion and money laundering more difficult. The regulator could even determine the purpose for which the funds are to be used, and such money could even have a limited time validity option. This would prevent a situation like the one in the United States, when many recipients of stimulus cheques didn’t spend the money but saved or invested it on capital markets. Moreover, central bankers could target support at specific people and penalise certain groups with negative rates.
Given all this, it will come as little surprise that of all the major countries it is China that is currently the closest to possibly introducing CBDC, and there is even talk of fully replacing cash with a digital yuan. Big Brother’s dream of tracking all monetary transactions in the economy may thus come true.
Sweden’s central bank is also actively involved in this issue, as it has seen a steady decline in the volume of cash transactions in the economy for a long time.
