As digital currency becomes increasingly popular across the globe, countries from the U.K. to China to the U.S. are evaluating Central Bank Digital Currency (CBDC). The central bank of the Bahamas is the first country to officially issue a digital currency, the Bahamian Sand Dollar, while El Salvador recently recognized Bitcoin as legal tender.
But what exactly is a Central Bank Digital Currency and how it is different from cryptocurrency such as bitcoin?
While most people hear “digital currency” and immediately think bitcoin, CBDC is not a cryptocurrency. Rather, it is a digital currency issued by a central bank, as opposed to a more volatile decentralized digital asset like cryptocurrency.
Cryptocurrency is created utilizing Distributed Ledger Technology (DLT) exclusively. CBDCs are issued by a central bank directly with or without DLT and generally pegged to the value of a fiat currency.
In the U.S., currency currently takes the form of notes and coins – cash – and can be thought of as a token-based form of money. Central Bank Digital Currency would introduce an electronic record, or digital token, as another form of currency.
There are several models being proposed to support the management of CBDCs. However, regardless of the design, the central bank is the always the only party that issues the CBDC and the form of the CBDC and how consumers and businesses access and transfer it is what varies.
As countries explore the different CBDC models, they must also evaluate the associated challenges and benefits. Clear challenges of CBDC include concerns surrounding security and money laundering. An anonymized, tokenized CBDC would present almost insurmountable obstacles to monitoring financial transactions as a tool for identifying illicit activity.
Among the perhaps less apparent challenges are how CBDCs could impact deposits. A unique feature of cash is that it is not interest-bearing; however, a central bank could choose to issue an interest-bearing CBDC. The central bank chosen rate would affect rates offered by banks, which would in turn affect deposits.
CBDCs are not without their upsides, though. The most immediate benefits a CBDC could possibly offer are more efficiencies when it comes to settlement of wholesale transactions and improvements to the current electronic benefits payment process. CBDCs can also facilitate greater inclusion for those who may be unbanked or under banked.
Closer to home, in the United States the debate surrounding CBDCs is becoming more robust. In a recent Senate Banking Committee hearing, lawmakers and scholars explored issues and opportunities. Some congressional leaders have expressed cynicism regarding the Federal Reserve entering this space. The major concerns involve ensuring that a Federal Reserve Bank issued CBDC will solve for issues related to access, transparency, stability and security—issues that have arisen as other digital currencies have been rolled out over the last four to five years.
Any CBDC will require ratification by Congress so consensus and support from our political leaders will be critical to the realization of a CBDC in the U.S.
Given both the drawbacks and the possible advantages, the path forward for CBDCs is uncertain. There are many choices and decisions to be made when it comes to CBDCs and each of those decisions could lead to very different outcomes. Regions is committed to monitoring developments regarding CBDC, as well as cryptocurrency, and providing customers with guidance and advice to make their financial lives easier.