As digital currencies have rapidly proliferated in the private sector, with Bitcoin and Ethereum as two noted examples among a sizable and growing population of other cryptocurrencies, governments have begun to carefully evaluate—and some have already issued—CBDCs to replace their national currency. With entities such as the World Economic Forum issuing CBDC tool kits for policymakers and a consortium of academics, nonprofits, financial institutions, and governments developing pilot programs for CBDCs, the race toward widespread digital currencies is on.
Central bank adoption of CBDCs is moving beyond experimentation
Source: Bank for International Settlements (BIS) survey, 2021.
A brief history of CBDCs
The Bahamas became the first nation to introduce a CBDC widely with the launch of Sand Dollar in October 2020. As of October 2021, there were ongoing CBDC pilots preparing for a possible launch in 26 jurisdictions. Overall, 81 countries representing over 90% of global GDP were engaged in some way with CBDCs. Nigeria became the first African country to launch a digital currency, the eNaira, in October 2021.
Meanwhile, China’s state-sponsored digital currency, the digital renminbi (or e-CNY), is being developed with cross-border use. The People’s Bank Of China (PBoC), the country’s central bank, defined e-CNY as “the digital version of fiat currency issued by the PBoC and operated by authorized operators. It’s a value-based, quasi-account-based and account-based hybrid payment instrument, with legal tender status and loosely coupled account linkage.” In a recent white paper, the PBoC noted “improvement of cross-border payments” as a key objective.
The United States currently has two CBDC initiatives under way. The first is led by the Federal Reserve Bank of Boston in collaboration with the Massachusetts Institute of Technology, while the other is led by The Digital Dollar Foundation and Accenture. In late September, U.S. Federal Reserve (Fed) Chair Jerome Powell said that the Fed is “working proactively to evaluate whether to issue a CBDC and, if so, in what form.” He added: “I don’t think we’re behind. I think it’s more important to do this right than to do it fast.” But the urgency to act isn’t lost on the Fed. In May, Governor Lael Brainard said, “Given the potential for CBDCs to gain prominence in cross-border payments and the reserve currency role of the dollar, it is vital for the United States to be at the table in the development of cross-border standards.”
What are the potential benefits and risks of CBDCs?
As alternatives to traditional forms of fiat currency, CBDCs are issued by a central bank and are intended to provide government-backed digital currency that can facilitate safe, direct, and instant transactions—bypassing more heavily mediated conventional pathways—and can be stored in a central bank wallet situated outside the private banking system. Hailed by some as a promising path to financial democratization for populations with little to no access to traditional bank platforms for financial transactions, CBDCs’ potential benefits and risks are under close investigation for their transformative economic potential.
Citing a variety of positive benefits, researchers at the World Economic Forum’s Digital Currency Governance Consortium (DCGC) have outlined three areas of risk and opportunity for CBDCs.
The Digital Currency Governance Consortium sees three broad issue areas for CBDCs
Source: World Economic Forum Digital Currency Governance Consortium, January 2021.
As the DCGC has discussed, each issue area—technology, regulation, and the value proposition for unbanked or underserved populations—should prompt extensive testing, data collection, and deliberative evaluation.
The potential benefits of CBDCs
The potential advantages of central bank digital currencies may well depend on the economic situation within the country. The International Monetary Fund cites several potential benefits:
- Cost efficiencies: Thanks to their digital nature, CBDCs could make payment systems more cost-effective. This is true especially for geographically large countries, where the management and distribution of physical cash can be quite expensive.
- Financial inclusion: In some countries, large percentages of the population don’t deposit their savings in banks. CBDCs could promote financial inclusion among these unbanked populations by giving them access to a safe place for their savings and, eventually, access to credit.
- Cross-border transactional efficiencies: CBDCs could improve cross-border payments, which can be slow, expensive, and often not easily accessible. Instead of long payment chains between multilayered correspondent banks, CBDCs could be traded directly, if they share the same technical standards, data, and compliance requirements.
The potential disadvantages of CBDCs
There could be some limitations and drawbacks to CBDCs as well. Some of the risks include:
- Privacy issues: CBDCs may pose a threat to privacy. The central authority that will be responsible for collecting and distributing identification and transaction data will have access to all monetary transactions. In addition to the threat of central banks disallowing or curbing transactions between citizens, the data could be vulnerable to hacks or misuse, if leaked.
- Regulatory hurdles: Some of the legal and regulatory issues related to CBDCs still need to be figured out. These issues could lead to long-term delays in the execution of cross-border payments.
- Banking sector disruption: CBDCs could lead to banking sector disintermediation, such as mass withdrawals of wealth, if people decide to hold CBDCs in large numbers. To prevent such an occurrence, banks may need to offer higher interest rates on deposits or improved payment services, which could lead to smaller profit margins.
How are CBDCs different from cryptocurrencies?
Cryptocurrencies are a reaction to government regulation of fiat currency or money. For example, with Bitcoin’s decentralized blockchain technology, there’s no central entity in charge of financial transactions that’s able to regulate its use, stabilize its value, and influence its continuing development. CBDCs are government issued and, therefore, will work with centralized blockchain technology, in which only a few entities such as central banks can access or alter the blockchain. These central entities will have the power to decide who has access to the blockchain and to what extent.
Cryptocurrencies are sometimes created with limits, which also helps add to the perceived value, essentially tying it to the fact that supply is limited. For example, the inventor of Bitcoin, Satoshi Nakamoto, capped the number of Bitcoins at 21 million, meaning there will only ever be 21 million Bitcoins in existence. However, each country has its own central bank, which can decide to add or remove money to or from the country’s supply depending on demand, economic conditions, and other factors. Central banks are likely to take a similar approach with CBDCs.
With the power of central banks behind them, CBDCs could have immense reach. However, the ultimate role of CBDCs remains unclear, and whether and how they dampen current market fervor for decentralized cryptocurrencies remains to be seen. While innovation in fintech is exciting, and seems to promise greater access to financial transactions for historically underserved populations, there may still be a long way to go for us to envision a world with multiple CBDCs working seamlessly together.
Neither John Hancock Investment Management nor any of its affiliated companies offer cryptocurrency such as blockchain or Bitcoin. This commentary is provided for informational purposes only and is not an endorsement of any security, mutual fund, sector, cryptocurrency, commodity, or index. No forecasts are guaranteed. The information contained here is based on sources believed to be reliable, but it is neither all inclusive nor guaranteed by John Hancock Investment Management.
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