The Digital Currency Dilemma – Will CBDCs Revolutionize Finance or Flop?

The Digital Currency Dilemma – Will CBDCs Revolutionize Finance or Flop?

Since the first retail CBDC, the Sand Dollar, launched in the Bahamas in 2019, governments across the globe have been actively exploring the digitalization path.

Last month, Bundesbank president Joachim Nagel urged central banks to adopt digital currencies as soon as possible at the BIS Innovation Summit. A BIS survey found that 90% of banks are considering central bank digital currencies (CBDCs), and over 50% are working on a pilot. 

Are CBDCs a leap towards a brighter future or instruments of control, and how close are we to full transition? Let’s discuss the current agenda.

CBDCs – Friend or Foe?

The IMF claims CBDCs can improve cross-border payment efficiency, which is the key reason for their adoption among oil exporter countries like Kuwait, Oman, Qatar, and the United Arab Emirates. 

Furthermore, CBDCs promote financial inclusion in developing economies, serving as an entry point to the broader financial system.

The WEF highlights that CBDCs help counter criminal activity like money laundering and terrorism financing, thanks to their traceability. 

Key motivation for the development and research of central bank digital currency (CBDC) among central banks as of 2023
Source: Statista

CBDCs’ convenience and accessibility are undoubtedly appealing, but some argue they would further increase government surveillance, which has already been a lingering concern among the general public. 

However, governments deem these suspicions unfounded. For example, the FED Chair Powell said the US is nowhere near pursuing a CBDC and has no intention of spying on citizens.

Moreover, digital currencies could limit banks’ ability to implement monetary policies.

Like any experiment, this new approach could have unforeseen consequences for the global financial system, such as increasing inflation. 

A Mastercard representative notes that implementing CBDCs is extremely difficult. Consumers are too comfortable with cash and cards, so there’s not enough justification for the switch

Will CBDCs Catch On? Early Stumbles Cast Doubt, But Innovation Continues

To date, only the Bahamas, Jamaica, and Nigeria have launched CBDCs. However, all three face issues with adoption. IMF data shows over 98% of Nigerian digital wallets gather dust. 

The Jamaican government aimed to drive adoption by introducing a JMD$2,500 bonus for the first 100K citizens to use the Jam-Dex, but after an initial bump, circulation of the CBDC stalled due to limited acceptance. 

Similarly, despite numerous educational campaigns and promotions, the Sand Dollar accounts for only 0.19% of the total circulating money in the Bahamas as of 2023.

These examples of initial hurdles haven’t stopped other governments from attempting to implement CBDCs. 

On June 18, the Central Bank of Iran announced the launch of a digital rial pilot scheme. Starting on June 21, the pilot will roll out on the island of Kish, a popular tourist destination operating as a free trade zone. 

Where central banks have issued digital currencies

India leads the race with its digital rupee development, undertaking retail and wholesale pilots to issue a full-scale CBDC later in 2024

According to a PwC report, Ukraine, Thailand, Japan, Sweden, the Republic of Korea, and Australia have also invested significantly in CBDC research and pilot programs. 

Top 10 retail CBDC projects

The EU followed suit, laying out a €1.2B plan for the digital euro’s development. According to reports, this plan should reduce the euro zone’s reliance on American payment systems like Visa and Mastercard. 

Stablecoins – Savior or Snake Oil?

CBDCs aren’t a government’s version of Bitcoin.

Crypto advocates stress that CBDCs are ‘very dangerous’ due to their centralized nature.

Governments could stop citizens’ spending with the tap of a button, whether to control economic volatility or punish political opponents. 

Like CBDCs, crypto facilitates efficient cross-border transactions and promotes the inclusion of the unbanked population. Unlike CBDCs, crypto doesn’t give the government full control over peoples’ wallets.

Stablecoins are often portrayed as a decentralized alternative to CBDCs due to their relatively low volatility. However, according to BIS, stablecoins are rarely used for transactions outside the crypto ecosystem

Few countries have clear stablecoin regulations, but even those that do don’t rush to embrace widespread adoption. In fact, the EU’s MiCA legislation outlines that the European Central Bank may prohibit stablecoin issuance if deemed necessary, for example, due to monetary policy interference. 

Deutsche Bank argues stablecoins lack transparency, credibility, and reserve backing, as evidenced by the 2023 $USTC and $LUNA collapse

Distribution of assets held as reserves

US lawmakers, too, have tightened their grip on stablecoins with the proposed Defense Bill amendment. Analysts believe the bill includes KYC and AML measures stablecoin issuers could not implement. 

Presumably, governments are hesitant to promote the widespread adoption of stablecoins due to the lack of traceability and questionable stability. While there’s yet no solution to the former, the world’s largest stablecoin issuer, Tether, proposed a gold-backed crypto to minimize the risk of de-pegging. 

Stablecoin issuers might have to find common ground with lawmakers if they want decentralized assets to coexist with CBDCs.

Final Thoughts 

While there’s a surge in CBDC exploration, their adoption remains patchy. Balancing privacy with control and maintaining economic stability while introducing new financial instruments isn’t something central banks can achieve overnight. 

Unfortunately for crypto adepts, stablecoins aren’t the silver bullet solution either. The global financial system finds itself at a crossroads, and the race for digital currency dominance is far from over. The first country to establish a widely adopted CBDC could set a standard for the entire system and even gain political influence.  

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