Central bank digital currency
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A central bank digital currency (CBDC) (also called digital fiat currency or digital base money) is a
digital currency Digital currency (digital money, electronic money or electronic currency) is any currency, money, or money-like asset that is primarily managed, stored or exchanged on digital computer systems, especially over the internet. Types of digital cu ...
issued by a
central bank A central bank, reserve bank, or monetary authority is an institution that manages the currency and monetary policy of a country or monetary union, and oversees their commercial banking system. In contrast to a commercial bank, a central ba ...
, rather than by a
commercial bank A commercial bank is a financial institution which accepts deposits from the public and gives loans for the purposes of consumption and investment to make profit. It can also refer to a bank, or a division of a large bank, which deals with cor ...
. A report by the
Bank for International Settlements The Bank for International Settlements (BIS) is an international financial institution owned by central banks that "fosters international monetary and financial cooperation and serves as a bank for central banks". The BIS carries out its work thr ...
states that, although the term "central bank digital currency" is not well-defined, "it is envisioned by most to be a new form of central bank money ..that is different from balances in traditional reserve or settlement accounts." The present concept of CBDCs was inspired by
Bitcoin Bitcoin ( abbreviation: BTC; sign: ₿) is a decentralized digital currency that can be transferred on the peer-to-peer bitcoin network. Bitcoin transactions are verified by network nodes through cryptography and recorded in a public distr ...
and similar
blockchain A blockchain is a type of distributed ledger technology (DLT) that consists of growing lists of records, called ''blocks'', that are securely linked together using cryptography. Each block contains a cryptographic hash of the previous block, a ...
-based
cryptocurrencies A cryptocurrency, crypto-currency, or crypto is a digital currency designed to work as a medium of exchange through a computer network that is not reliant on any central authority, such as a government or bank A bank is a financial i ...
, but differs from such a
virtual currency Virtual currency, or virtual money, is a digital currency that is largely unregulated and issued and usually controlled by its developers and used and accepted electronically among the members of a specific virtual community. In 2014, the Europ ...
and cryptocurrency in that a CBDC is or would be issued by a
state State may refer to: Arts, entertainment, and media Literature * ''State Magazine'', a monthly magazine published by the U.S. Department of State * ''The State'' (newspaper), a daily newspaper in Columbia, South Carolina, United States * ''Our S ...
. Most CBDC implementations will likely not use or need any sort of
distributed ledger A distributed ledger (also called a shared ledger or distributed ledger technology or DLT) is the consensus of replicated, shared, and synchronized digital data that is geographically spread (distributed) across many sites, countries, or institutio ...
such as a
blockchain A blockchain is a type of distributed ledger technology (DLT) that consists of growing lists of records, called ''blocks'', that are securely linked together using cryptography. Each block contains a cryptographic hash of the previous block, a ...
. CBDCs are presently mostly in the hypothetical stage, with some in proof-of-concept programmes. According to ECB's chief Christine Lagarde, more than 80 central banks are looking at digital currencies. China's digital RMB was the first digital currency to be issued by a major economy. As of July 2022, four central banks have launched a CBDC: the
Central Bank of The Bahamas The Central Bank of The Bahamas is the reserve bank of The Bahamas based in the capital Nassau. The bank was established on 1 June 1974 but traces its origins to the currency board established in 1919. The bank carries out the independent mon ...
(
Sand Dollar Sand dollars (also known as a sea cookie or snapper biscuit in New Zealand, or pansy shell in South Africa) are species of flat, burrowing sea urchins belonging to the order Clypeasteroida. Some species within the order, not quite as flat, are k ...
), the
Eastern Caribbean Central Bank The Eastern Caribbean Central Bank (ECCB) is the central bank for the Eastern Caribbean dollar and is the monetary authority for the members of the Organisation of Eastern Caribbean States (OECS), with the exception of the British Virgin Islands ...
( DCash), the
Central Bank of Nigeria The Central Bank of Nigeria (CBN) is the central bank and apex monetary authority of Nigeria established by the CBN Act of 1958 and commenced operations on 1 July 1959. The major regulatory objectives of the bank as stated in the CBN Act are ...
( e-Naira) and the Bank of Jamaica ( JamDex). Some states have also issued, or have considered issuing,
cryptocurrencies A cryptocurrency, crypto-currency, or crypto is a digital currency designed to work as a medium of exchange through a computer network that is not reliant on any central authority, such as a government or bank A bank is a financial i ...
: these include
Venezuela Venezuela (; ), officially the Bolivarian Republic of Venezuela ( es, link=no, República Bolivariana de Venezuela), is a country on the northern coast of South America, consisting of a continental landmass and many islands and islets in th ...
( Petro) and the
Marshall Islands The Marshall Islands ( mh, Ṃajeḷ), officially the Republic of the Marshall Islands ( mh, Aolepān Aorōkin Ṃajeḷ),'' () is an independent island country and microstate near the Equator in the Pacific Ocean, slightly west of the Internati ...
(
Sovereign ''Sovereign'' is a title which can be applied to the highest leader in various categories. The word is borrowed from Old French , which is ultimately derived from the Latin , meaning 'above'. The roles of a sovereign vary from monarch, ruler or ...
). These cryptocurrencies are often considered with the intent of increasing a state's independence from global financial systems, such as by reducing dependence on a foreign currency or by evading
international sanctions International sanctions are political and economic decisions that are part of diplomatic efforts by countries, multilateral or regional organizations against states or organizations either to protect national security interests, or to protect in ...
.


History

Central banks have directly implemented
e-money Digital currency (digital money, electronic money or electronic currency) is any currency, money, or money-like asset that is primarily managed, stored or exchanged on digital computer systems, especially over the internet. Types of digital cu ...
previously, such as
Finland Finland ( fi, Suomi ; sv, Finland ), officially the Republic of Finland (; ), is a Nordic country in Northern Europe. It shares land borders with Sweden to the northwest, Norway to the north, and Russia to the east, with the Gulf of B ...
's Avant stored value e-money card in the 1990s. In 2000, the project was launched in
Czechia The Czech Republic, or simply Czechia, is a landlocked country in Central Europe. Historically known as Bohemia, it is bordered by Austria to the south, Germany to the west, Poland to the northeast, and Slovakia to the southeast. The Cz ...
, enabling the implementation of so-called micropayments on the Internet. For payments, users used the virtual currency Q, the fair value of which is tied to a
fixed exchange rate A fixed exchange rate, often called a pegged exchange rate, is a type of exchange rate regime in which a currency's value is fixed or pegged by a monetary authority against the value of another currency, a basket of other currencies, or another m ...
against the
Czech koruna The koruna, or crown, (sign: Kč; code: CZK, cs, koruna česká) has been the currency of the Czech Republic since 1993. The koruna is one of the European Union's 9 currencies, and the Czech Republic is legally bound to adopt the euro currenc ...
in the ratio of 100 Q = CZK 1. The two currencies are fully convertible. The author of the project was . Project I LIKE Q was terminated in 2003 due to an amendment to Czech law, which at that time did not provide for this form of payment. In 2021, the same group introduced project which is a type of digital currency enriched with smart contracts aka drone money. The present concept of "central bank digital currency" may have been partially inspired by
Bitcoin Bitcoin ( abbreviation: BTC; sign: ₿) is a decentralized digital currency that can be transferred on the peer-to-peer bitcoin network. Bitcoin transactions are verified by network nodes through cryptography and recorded in a public distr ...
and similar
blockchain A blockchain is a type of distributed ledger technology (DLT) that consists of growing lists of records, called ''blocks'', that are securely linked together using cryptography. Each block contains a cryptographic hash of the previous block, a ...
-based
cryptocurrencies A cryptocurrency, crypto-currency, or crypto is a digital currency designed to work as a medium of exchange through a computer network that is not reliant on any central authority, such as a government or bank A bank is a financial i ...
. It is also a known concept in the field of economics, whereby the central bank enables citizens to hold accounts with it, providing a reliable and safe public savings or payments medium ("retail" or "general-purpose" CBDC). The
Bank for International Settlements The Bank for International Settlements (BIS) is an international financial institution owned by central banks that "fosters international monetary and financial cooperation and serves as a bank for central banks". The BIS carries out its work thr ...
(BIS) published a report in December 2020 listing the known CBDC wholesale and retail projects at that time. By April 2021, there would be "at least 80 central banks around the world that are looking at digital currencies." Another 2020 BIS survey found that 86% of central banks were examining the advantages and disadvantages of launching CBDCs, although only 14% were in advanced stages of development (such as pilot programs).


Implementation

A central bank digital currency would likely be implemented using a
database In computing, a database is an organized collection of data stored and accessed electronically. Small databases can be stored on a file system, while large databases are hosted on computer clusters or cloud storage. The design of databases sp ...
run by the central bank,
government A government is the system or group of people governing an organized community, generally a state. In the case of its broad associative definition, government normally consists of legislature, executive, and judiciary. Government is a ...
, or approved
private-sector The private sector is the part of the economy, sometimes referred to as the citizen sector, which is owned by private groups, usually as a means of establishment for profit or non profit, rather than being owned by the government. Employment The ...
entities. The database would keep a record (with appropriate privacy and
cryptographic Cryptography, or cryptology (from grc, , translit=kryptós "hidden, secret"; and ''graphein'', "to write", or '' -logia'', "study", respectively), is the practice and study of techniques for secure communication in the presence of adve ...
protections) of the amount of money held by every entity, such as people and corporations. In contrast to cryptocurrencies, a central bank digital currency would be centrally controlled (even if it was on a
distributed database A distributed database is a database in which data is stored across different physical locations. It may be stored in multiple computers located in the same physical location (e.g. a data centre); or maybe dispersed over a network of interconnect ...
), and so a
blockchain A blockchain is a type of distributed ledger technology (DLT) that consists of growing lists of records, called ''blocks'', that are securely linked together using cryptography. Each block contains a cryptographic hash of the previous block, a ...
or other
distributed ledger A distributed ledger (also called a shared ledger or distributed ledger technology or DLT) is the consensus of replicated, shared, and synchronized digital data that is geographically spread (distributed) across many sites, countries, or institutio ...
would likely not be required or useful - even as they were the original inspiration for the concept.


Characteristics

A CBDC is a high-security digital instrument; like paper banknotes, it is a means of payment, a unit of account, and a store of value. And like paper currency, each unit is uniquely identifiable to prevent
counterfeiting To counterfeit means to imitate something authentic, with the intent to steal, destroy, or replace the original, for use in illegal transactions, or otherwise to deceive individuals into believing that the fake is of equal or greater value tha ...
. CBDC will have implications for commercial banks, probably in the field of lowering banks' commissions, no big customer data-selling ability, accumulating the deposits and deposit policies and credit policies due to higher funding costs for banks. Digital
fiat currency Fiat money (from la, fiat, "let it be done") is a type of currency that is not backed by any commodity such as gold or silver. It is typically designated by the issuing government to be legal tender. Throughout history, fiat money was sometime ...
is part of the
base money In economics, the monetary base (also base money, money base, high-powered money, reserve money, outside money, central bank money or, in the UK, narrow money) in a country is the total amount of money created by the central bank. This include ...
supply, together with other forms of the currency. As such, DFC is a liability of the central bank just as physical currency is. It is a digital
bearer instrument A bearer instrument is a document that entitles the holder of the document to rights of ownership or title to the underlying property, such as shares or bonds. Unlike normal registered instruments, no record is kept of who owns bearer instruments ...
that can be stored, transferred and transmitted by all kinds of digital payment systems and services. The validity of the digital fiat currency is independent of the digital payment systems storing and transferring the digital fiat currency. Proposals for CBDC implementation often involve the provision of universal bank accounts at the central banks for all citizens.


Benefits and impacts

Digital fiat currency is currently being studied and tested by governments and central banks in order to realize the many positive implications it contributes to financial inclusion, economic growth, technology innovation and increased transaction efficiencies. Here is a list of potential advantages: * Technological efficiency: instead of relying on intermediaries such as banks and clearing houses, money transfers and payments could be made in real time, directly from the payer to the payee. Being real time has some advantages: ** Reduces risk: payment for goods and services often needs to be done in a timely manner and when payment verification is slow, merchants usually accept the risk of some payments not succeeding in exchange for faster service to customers. When these risks are eliminated with instant payment verifications, merchants no longer need to use intermediaries to handle the risk or to absorb the risk cost themselves. ** Reduces complexity: merchants will not need to separately keep track of transactions that are slow (where the customer claims to have paid but the money has not arrived yet), therefore eliminate the waiting queue, which could simplify the transaction process from payment to rendition of goods/services. **Reduces (or eliminates) transaction fees: current payment systems like
Visa Visa most commonly refers to: *Visa Inc., a US multinational financial and payment cards company ** Visa Debit card issued by the above company ** Visa Electron, a debit card ** Visa Plus, an interbank network *Travel visa, a document that allows ...
, Mastercard,
American Express American Express Company (Amex) is an American multinational corporation specialized in payment card services headquartered at 200 Vesey Street in the Battery Park City neighborhood of Lower Manhattan in New York City. The company was found ...
etc. have a fee attached to each transaction and lowering or eliminating these fees could lead to widespread price drops and increased adoption of digital payments. * Financial inclusion: safe money accounts at the central banks could constitute a strong instrument of financial inclusion, allowing any legal resident or citizen to be provided with a free or low-cost basic bank account. * Preventing illicit activity: A CBDC makes it feasible for a central bank to keep track of the exact location of every unit of the currency (assuming the more probable centralized, database form) ** Tax collection: It makes
tax avoidance Tax avoidance is the legal usage of the tax regime in a single territory to one's own advantage to reduce the amount of tax that is payable by means that are within the law. A tax shelter is one type of tax avoidance, and tax havens are jurisdict ...
and
tax evasion Tax evasion is an illegal attempt to defeat the imposition of taxes by individuals, corporations, trusts, and others. Tax evasion often entails the deliberate misrepresentation of the taxpayer's affairs to the tax authorities to reduce the taxp ...
much more difficult, since it would become impossible to use methods such as
offshore banking An offshore bank is a bank regulated under international banking license (often called offshore license), which usually prohibits the bank from establishing any business activities in the jurisdiction of establishment. Due to less regulation and ...
and
unreported employment Unreported employment, also known as money under the table, working under the table, off the books, cash-in-hand, or illicit work is illegal employment that is not reported to the government. The employer or the employee often does so for tax evas ...
to hide financial activity from the central bank or government. ** Combating crime: It makes it much easier to spot criminal activity (by observing financial activity), and thus put an end to it. Furthermore, in cases where criminal activity has already occurred, tracking makes it much harder to successfully
launder money Money laundering is the process of concealing the origin of money, obtained from illicit activities such as drug trafficking, corruption, embezzlement or gambling, by converting it into a legitimate source. It is a crime in many jurisdictions ...
, and it would often be straightforward to instantly reverse a transaction and return money to the victim of the crime. * Proof of transaction: a digital record exists to prove that money changed hands between two parties which avoids problems inherent to cash such as short-changing, cash theft and conflicting testimonies. * Protection of money as a public utility: digital currencies issued by central banks would provide a modern alternative to physical cash – whose abolition is currently being envisaged. * Safety of payments systems: A secure and standard interoperable digital payment instrument issued and governed by a Central Bank and used as the national digital payment instruments boosts confidence in privately controlled money systems and increases trust in the entire national payment system while also boosting competition in payment systems. * Preservation of seigniorage income: public digital currency issuance would avoid a predictable reduction of
seigniorage Seigniorage , also spelled seignorage or seigneurage (from the Old French ''seigneuriage'', "right of the lord (''seigneur'') to mint money"), is the difference between the value of money and the cost to produce and distribute it. The term can be ...
income for governments in the event of a disappearance of physical cash. * Banking competition: the provision of free bank accounts at the central bank offering complete safety of money deposits could strengthen competition between banks to attract bank deposits, for example by offering once again remunerated sight deposits. * Monetary policy transmission: the issuance of central bank base money through transfers to the public could constitute a new channel for monetary policy transmission (i.e.
helicopter money Helicopter money is a proposed unconventional monetary policy, sometimes suggested as an alternative to quantitative easing (QE) when the economy is in a liquidity trap (when interest rates near zero and the economy remains in recession). Althoug ...
), which would allow more direct control of the money supply than indirect tools such as
quantitative easing Quantitative easing (QE) is a monetary policy action whereby a central bank purchases predetermined amounts of government bonds or other financial assets in order to stimulate economic activity. Quantitative easing is a novel form of monetary pol ...
and
interest rates An interest rate is the amount of interest due per period, as a proportion of the amount lent, deposited, or borrowed (called the principal sum). The total interest on an amount lent or borrowed depends on the principal sum, the interest rate, th ...
, and possibly lead the way towards a full reserve banking system. In digital Yuan trial in Shenzhen, the CBDC was programmed with an expiration date, which encouraged spending and discouraged money from sitting in a saving account. In the end, 90% of vouchers were spent in shops. * Financial safety: CBDC would limit the practice of
fractional reserve banking Fractional-reserve banking is the system of banking operating in almost all countries worldwide, under which banks that take deposits from the public are required to hold a proportion of their deposit liabilities in liquid assets as a reserve, ...
and potentially render deposit guarantee schemes less needed.


Risks

Despite having potential advantages, CBDCs remain a controversial topic, and there are risks associated with their implementation. * Banking system disintermediation: With the ability to provide digital currency directly to its citizens, one concern is that depositors would shift out of the banking system. Indeed, in the last century, commercial banks have created money thanks to deposits in addition to a number of other ways. Formally they have used 2 methods:
fractional reserve banking Fractional-reserve banking is the system of banking operating in almost all countries worldwide, under which banks that take deposits from the public are required to hold a proportion of their deposit liabilities in liquid assets as a reserve, ...
and zero reserve. Zero reserve: Today,
commercial banks A commercial bank is a financial institution which accepts deposits from the public and gives loans for the purposes of consumption and investment to make profit. It can also refer to a bank, or a division of a large bank, which deals with corp ...
in some countries (US, UK, EU, etc) don't need a reserve requirement anymore. Indeed, every time a subject (a person, a corporation, etc) asks for a
loan In finance, a loan is the lending of money by one or more individuals, organizations, or other entities to other individuals, organizations, etc. The recipient (i.e., the borrower) incurs a debt and is usually liable to pay interest on that d ...
, and that subject offers a
loan guarantee A loan guarantee, in finance, is a promise by one party (the guarantor) to assume the debt obligation of a borrower if that borrower defaults. A guarantee can be limited or unlimited, making the guarantor liable for only a portion or all of the d ...
(a private property like a car, a building, etc), the bank temporarily creates a new deposit (money), lends this money to them, and when the borrower pays off the loan plus the
interest In finance and economics, interest is payment from a borrower or deposit-taking financial institution to a lender or depositor of an amount above repayment of the principal sum (that is, the amount borrowed), at a particular rate. It is distinct ...
the initial deposit is deleted, and the bank keeps the interest. In the real world, zero reserve and fractional reserve are the same, because the banks are able to avoid the reserve requirements. CBDCs are fully reserved, so if a person wants this form of money, they just buy it from the central bank. In this case commercial banks don't create debt or new money, and they don't earn any interest. Customers may deem the safety,
liquidity Liquidity is a concept in economics involving the convertibility of assets and obligations. It can include: * Market liquidity, the ease with which an asset can be sold * Accounting liquidity, the ability to meet cash obligations when due * Liqui ...
, solvibility, and publicity of CBDCs to be more attractive, weakening the balance sheet position of commercial banks. In the extreme, this could precipitate potential
bank run A bank run or run on the bank occurs when many clients withdraw their money from a bank, because they believe the bank may cease to function in the near future. In other words, it is when, in a fractional-reserve banking system (where banks no ...
s and thus make banks' funding positions weaker. However, the
Bank of England The Bank of England is the central bank of the United Kingdom and the model on which most modern central banks have been based. Established in 1694 to act as the English Government's banker, and still one of the bankers for the Government of ...
found that if the introduction of CBDC follows a set of core principles, the risk of a system-wide run from bank deposits to CBDC is addressed. A central bank could also limit the demand of CBDCs by setting a ceiling on the amount of holdings. * Centralization: Since most central bank digital currencies are centralized, rather than decentralized like most cryptocurrencies, the controllers of the issuance of CBDCs can add or remove money from anyone's account with a flip of a switch. In contrast, cryptocurrencies with a
distributed ledger A distributed ledger (also called a shared ledger or distributed ledger technology or DLT) is the consensus of replicated, shared, and synchronized digital data that is geographically spread (distributed) across many sites, countries, or institutio ...
such as Bitcoin prevent this unless a group of users controlling more than 50% of
mining Mining is the extraction of valuable minerals or other geological materials from the Earth, usually from an ore body, lode, vein, seam, reef, or placer deposit. The exploitation of these deposits for raw material is based on the economic via ...
power is in agreement. * Digital dollarization: A well-run foreign digital currency could become a replacement for a local currency for the same reasons as those described in
dollarization Currency substitution is the use of a foreign currency in parallel to or instead of a domestic currency. The process is also known as dollarization or euroization when the foreign currency is the dollar or the euro, respectively. Currency subs ...
. The announcement of Facebook's
Libra Libra generally refers to: * Libra (constellation), a constellation * Libra (astrology), an astrological sign based on the star constellation Libra may also refer to: Arts and entertainment * ''Libra'' (novel), a 1988 novel by Don DeLillo Musi ...
contributed to the increased attention to CBDCs by central bankers, as well as China's progress with DCEP to that of several Asian economies. * Privacy: ** "Governments have direct visibility of financial transactions", an "eagle-eyed view on the spending of everyone". ** Digital currency would give a country "broad new powers when it comes to surveillance and controlling its population." ** Data from tracing money routes could lead to losing financial privacy if the CBDC implementation does not have adequate privacy protections. This could lead to encouraging of self-censorship, deterioration of
freedom of expression Freedom of speech is a principle that supports the freedom of an individual or a community to articulate their opinions and ideas without fear of retaliation, censorship, or legal sanction. The right to freedom of expression has been recogni ...
and
association Association may refer to: *Club (organization), an association of two or more people united by a common interest or goal *Trade association, an organization founded and funded by businesses that operate in a specific industry *Voluntary associatio ...
, and ultimately to stalling social developments. * Government Social Manipulation: ** Digital currency "will simply become an extension of the surveillance state" and "it could see citizens fined in a split second for behaviors deemed undesirable. Dissidents and activists could see their wallets emptied or taken offline." ** Limiting individual freedom: "Digital currencies could also empower the state to make it impossible to donate to a vocal NGO" ** Limiting or prohibiting purchases of products: Digital currency could prohibit a "purchase alcohol on a weekday. " ** Digital currency " is also programmable. The government could theoretically give out money that expires within a certain period of time or money that could only be used on certain items, which could be used to induce behaviour that the government is seeking." ** Direct interaction with individuals: "In times of crisis, they enable governments to send aid and stimulus payments directly to the smartphones of affected citizens, regardless of whether the recipients have a bank account." ** Forcing consumer behavior: "Digital currencies can also be tailored to specific purposes. For example, in the Chinese pilot program, money has an expiration date of a few weeks because authorities are hoping to drive consumption"


References

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CBDC Digital Rupee
India b
Mudra Bank


External links



{{DEFAULTSORT:Central bank digital currency Central bank digital currencies, Monetary reform Numismatics