The risks of central bank digital currencies

The development of central bank digital currencies (CBDCs) remains a hot topic of discussion, and for good reason.

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Whether a solution or a risk to the global financial system, CBDCs are where the world looks for answers.

Financial crimes and Internet-related fraudulent activities show no signs of abating. As a result, it is necessary to protect the mechanisms of trade as a whole.

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It is part of this protection to find a solution to combat monetary and financial instability. Not just for countries, but for individuals who cannot access the financial inclusions provided by banking institutions.

According to Bank For International Settlements, 56 central banks are currently actively researching or developing their own form of digital currency.

The Bank for International Settlements (BIS) supports these findings with its study. In January 2020, the entity found that 80% of global central banking institutions are researching and developing a CBDC.

In fact, the percentage of central banks conducting proof-of-concept examinations is growing, reaching almost 50 percent.

Notably, 10% of central banks surveyed plan to implement a widely accessible retail CBDC in the next three years. And 20% plan to introduce a retail CBDC in the next six years.

The benefits of central bank digital currencies (CBDC)

There are concerns about CBDCs and what their implementations might bring. However, there are also some clear benefits to switching to an all-digital fiat currency.

A big benefit is the possible accessibility. CBDCs could make access to digital money and financial services more accessible for those who have been financially excluded because of their circumstances.

These can be elements such as immigration status, incarceration, past defaults, limited financial knowledge and, of course, poverty.

Furthermore, this would allow governments to easily manage digital money grants, especially during the next crisis.

According to the World Bank, more than 1.6 billion adults are considered “unbanked”. This refers to a person or entity that does not have access to a bank or similar financial organization.

This includes no access to checks or savings or even digital money provided by banking apps. This status also covers services such as insurance, loans, mortgages or financial protections of any kind.

Likewise, the Federal Deposit Insurance Corporation (FDIC) reported in the most recent National Survey of Unbanked Families that a total of 14.1 million adults in the United States are classified as unbanked.

CBDCs are a possible solution to this problem. They offer access without the restrictions of a bank account. Instead, a person could gain access simply through an app. This reduces the need to just owning a smartphone, something that has become much cheaper in recent years.

Another area where central bank digital currencies can prove beneficial is in the world of decentralized finance. Rather than an enemy of the market, some see CBDCs as a springboard to broader adoption of these tools and products.

“CBDCs are the main motivator for ordinary people to enter the new DeFi financial world. People can still use their choice of fiat currencies and also feel the magic of the blockchain’s security, efficiency and composition,” explains Furucombo CEO and co-founder Hsuan-Ting Chu.

“But a very important step to allow CBDCs to work efficiently is regulation. This is how governments will set the rules for newcomers and manage those already in the market. Uniswap’s recent move has already given us an example of how a DeFi protocol should prepare for regulation.”

China at the forefront

The issue of government regulation and management of central bank digital currencies is at the heart of the debate around digital currencies.

When it comes to which governments are already advancing on these assets, China leads the pack. The Asian country launched a pilot project in April 2020, which exists as the most advanced in the world to date.

Its version of digital currency is controlled and regulated by its central bank, allowing the Chinese government to observe and monitor payments in real time, denying anonymity by definition.

Since the launch of the digital Yuan, China has made several strides, with distribution estimates of more than $23 million in various tests of its digital currency currently in circulation.

“The central bank’s digital currencies will become a reality very soon in China. They have already piloted their digital yuan and hope to launch their CBDC in 2022,” said First Digital Trust COO Gunnar Jaerv, a leading custodian of Hong Kong’s digital assets.

“When other countries realize the potential that a CBDC can have on a country’s growth, we will see more acceptance of central bank digital currencies launched in the future, but that will take a long time. China has been way ahead of the entire world in the last 10 years. They started with WeChat and AliPay, and are now moving forward with CBDCs. ”

China’s advance in its digital yuan has caught the attention of governments in other countries. This includes the Biden administration.

The United States is eyeing its development. This is due to concerns that a Chinese CBDC will be used to circumvent sanctions and could negatively impact the superiority of the US dollar.

Institutional interest is spreading

Interest from international communities such as Japan, France and Australia are among the growing list of countries striving to develop a CBDC initiative.

For example, Russia recently announced its project to test a digital ruble by 2022. In addition, the Boston Fed is collaborating with the Massachusetts Institute of Technology to develop a CBDC.

The Central Bank of Nigeria recently announced a plan to launch a CBDC test code-named “GIANT” on October 1st. Digital currency will run on the open source blockchain Hyperledger Fabric.

The Monetary Authority of Singapore (MAS) asked financial technology companies to submit solutions for a retail model CBDC infrastructure.

CBDC Risks and Rewards

However, while the interest and potential benefits are apparent, that does not mean there are no risks and concerns.

This includes concerns that CBDCs will only reinforce the world’s toughest financial issues. Instead of being a solution as intended.

A 2021 report by the Fitch Ratings Agency concluded that “the widespread adoption of CBDCs can disrupt financial systems” if the associated risks are not managed.

These risks include cybersecurity threats, which have grown as more people around the world connect. He also noted concerns of financial disintermediation.

Another associated threat when it comes to CBDCs is the controls needed to prevent bank leaks and supply problems. Today, fiat currencies are controlled, in a way, by controlling their printing. However, when a currency is digital, this is not a restriction.

As much as central banks control the circulation and supply of money, whether they will make the proper transition to the digital space is another risk vector.

Privacy as a central issue

Alongside this control is the concern related to privacy. Market research conducted by the Official Forum of Monetary and Financial Institutions (OMFIF) on the essential components of a CBDC found privacy and security to be top concerns.

In the United States and Germany, 70% of respondents were most concerned about privacy as a key element of a potential CBDC.

Privacy is a monumental concern because a CBDC will make it easier for governments to view and track transactions.

Today, when consumers are using banks, most government agencies can already gain access to financial records. However, this only occurs through the execution of a court order.

While digital currencies can be a way to help the unbanked, they are also a way for governments to increase centralization.

As much as the national currency is a standard, there is a market where consumers choose which banking device will be used. They can choose their bank, adjust the terms and have some level of control.

There is a fear that central bank digital currencies (CBDCs) will consolidate this control. In this way, it will be difficult for citizens to maintain more autonomy over their finances.

The cryptocurrency dilemma

This is where the CBDC vs. cryptocurrencies usually enter. Bitcoin and other similar cryptocurrencies were designed with privacy and self-care in mind.

These assets can free users from government financial oversight and control and from the policies associated with central banks.

Many cryptocurrency traders believe these components are the lifeblood that fueled corruption and inflation.

“What is needed is an electronic payment system based on cryptographic evidence rather than trust,” writes Satoshi Nakamoto in his 2008 white paper. “Transactions that are computationally impractical to reverse protect sellers from fraud.”

However, some do not believe this is not a zero-sum game. CoinShares chief strategy officer Meltem Demiorors told Reuters that a CBDC “is structurally no different from a fiat currency and they are very complementary to cryptography, not competitive.”

CBDCs are an inevitability. Our world is going digital, and the need for a paper-based monetary system is already becoming null and void. The coming years will make the risks and rewards of a digital national currency clearer.

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