How Central Bank Digital Currencies (CBDCs) Will Reinvent the Global Financial System

KEY TAKEAWAYS

Growing fears that digital assets could undermine the growth of domestic currencies has turned central banks to consider launching Central Bank Digital Currencies. But how will CBDCs affect the traditional finance industry?

Central Bank Digital Currencies (CBDCs) have the potential to revolutionize the traditional financial industry.

The digital payments market is already projected to surpass $2 billion in 2023 in the United States as more people switch from cash to contactless. In Europe, the digital payments market is projected to reach $1.8 billion in 2023.

The surging popularity of cryptocurrencies has turned a number of governments to pay attention to the rising trend. Growing fears that digital assets could undermine the growth of domestic currencies has turned central banks to consider launching CBDCs.

What Are Central Bank Digital Currencies?

Central Bank Digital Currencies are essentially virtual versions of fiat currency issued by central governments.

As of 2023, 130 countries worldwide are exploring the potential launch of CBDCs, however, only 11 have so far fully launched a CBDC, including a number of countries in the Caribbean and Nigeria. CBDCs are also undergoing a pilot test in China, reaching 260 million people and being tested in over 200 scenarios. In the meantime, the European Central Bank is also on track to begin its pilot of the digital euro.

The CEO at BANXA Holdings Inc., Holger Arians, told Techopedia:

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“In a CBDC economy, individuals and businesses may choose to store their funds in CBDC accounts with the central bank. This would result in a decreased reliance on traditional bank deposit accounts, which would affect banks’ capacity to lend and generate interest income.”

Pros and Cons of CBDCs

One of the main roles that banks have in today’s economy is to take deposits, pool, and lend money to people and organizations needing the necessary funds, Fred Winchar, a banking expert and the president of MaxCash explained.

This means that, essentially, the introduction of CBDCs could affect the main role of traditional banks. Winchar explained: “The main potential challenges commercial banks will face in a CBDC-driven financial system is increased competition, which will see more consumers switch to CBDCs, leaving out banks.”

“Customers enjoy convenience, and they will be likely to prefer holding digital currencies with the central banks instead of holding funds in commercial banks. Therefore, commercial banks will have fewer customers, less profit, and fewer funds to lend.”

BANXA Holdings’ Arians added that in a CBDC-driven economy, tech integration could also act as a major hurdle but also a possible opportunity for commercial banks.

“While lower transaction fees and faster settlements that CBDCs offer might pose initial challenges to banking revenues, there is also tremendous potential in participating in creating the infrastructure to support a new digital financial system. Ultimately, commercial banks will likely play a large role in the implementation and adoption of CBDCs via public-private partnerships, as a central bank would look to utilize their infrastructure and client relationships to ensure success.”

In addition, some experts predict that the launch of CBDCs could see a lot of consumers withdraw their deposits from commercial banks, thus forcing them to look for new ways to make money which could further raise interest rates.

CBDCs and Cross-Border Transactions

CBDCs could potentially have a major impact on how cross-border transactions are carried out. This is because they can bring safety, interoperability, and efficiency, which is what would make them so suitable for cross border-transactions.

The distributed ledger technology of CBDCs could also help support cross-border transactions, Arians explained, reducing costs and offering financial inclusion to populations who might have otherwise been prevented from transacting.

Although, at the same time, it is also important to note that CBDCs will be designed differently in various countries.

“Some might be at the wholesale level, some might be at the retail level, but most likely, they will not be homogenous across the board. Therefore, there will most likely need to be a forex exchange to be able to trade one CBDC for another (similar to a forex exchange at a bank). How this will be regulated at a global level vs. regional level will need to be determined,” Pelli Wang, the co-founder of Bracket Labs, noted.

In addition, making cross-border transactions more effective will only come if CBDCs are designed using the Hippocratic Oath design.

CBDCs and Traditional Finance: Monetary Policies and More

BANXA Holdings’ Arians said that the implementation of CBDCs could provide central banks with new tools for mitigating inflation, interest rates, and money supply with greater precision than ever before.

“CBDCs might enable central banks to exercise finer and more immediate over economic operations, facilitating the implementation of new policies with heightening agility and accuracy.”

Wang added that if a central bank uses retail CBDCs, they could quickly inject liquidity into the market by directly issuing or airdropping stablecoins into individual digital wallets. This would be much faster and more efficient than cutting government checks or debit cards and mailing all that out to citizens.

“Moreover, they could program other monetary policies into these newly airdropped stablecoins, like carrying additional interest rates, and spending limits where they need to be used, or they will expire. With programmability, CBDC could be an extremely powerful tool for the government, but user privacy will need to be closely monitored,” Wang said.

In addition, CBDCs will make it easier for central banks to control the money supply, MaxCahs’s Winchar said, adding:

“CBDCs offer a resilient domestic payment system, easier-to-distribute targeted payments, more safety, and greater availability, which will help prevent and better manage financial crises.”

The Bottom Line

CBDCs stand poised to reshape the financial landscape, offering a digital revolution that addresses the rise of cryptocurrencies and the need for enhanced monetary control.

While their introduction could threaten to disrupt traditional banks’ role by allowing direct storage of funds with central banks, CBDCs also promise streamlined cross-border transactions and the potential for more precise monetary policy implementation.

Overall, the journey toward CBDC adoption presents both challenges and opportunities, marking a pivotal moment in the evolution of global finance.

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Iliana Mavrou

Iliana is an experienced crypto/tech journalist reporting on blockchain, regulation, DeFi, and Web3 industries. Before joining Techopedia, she contributed to a number of online publications, including Capital.com, Cryptonews, and Business2Community, among others. In addition to working in journalism, she also has experience in tech and crypto PR.  Iliana graduated from the City University of London with a degree in Journalism in 2021. She is currently pursuing a Master's degree in Communication.