How CBDCs Impact an Economy

Central bank digital currencies (CBDCs) are all the rage right now. These assets have been increasing since last year, and they continue to do so.

Today, estimates suggest that countries representing 90 percent of global GDP will launch CBDCs in the next decade. So, what exactly is the impact of these assets on economies?

The rise of CBDCs has been inspiring for sure. China started the race, launching trials for its digital yuan in 2020. Even with the global pandemic, problems for the digital yuan continued. Today, China’s progress has caused several other countries to make similar moves. We now have CBDC trials in Japan, Jamaica, France, Nigeria, etc.

The European Central Bank is also working on a CBDC that will span the entire region. This is in line with requests from many to commission a digital version of the Euro. Thus, slowly, the CBDC revolution is taking over the world indeed.

How CBCs Play Into Economies

To understand the impacts of a CBDC on a country’s economy, it is worth looking at what a CBDC is. Primarily, these assets function as digital versions of countries’ currencies. There are several characteristics that CBDCs should have, according to a research paper:

Value storage

Since money itself acts as a store of value, CBDCs should do the same thing. CBDCs could bear interest, especially when people keep them with local banks. This will give them a rate of return, possibly in line with some traditional risk-free assets. It could be government bonds, treasury bills, or some other type of government-issued security.

This interest rate on CBDCs could even serve as the primary tool that drives government decisions on monetary policy.

A medium of exchange

As expected, CBDCs should be able to help facilitate value exchange. Some CBDCs could be account-based, with users connecting their accounts to those of the central bank. In turn, the central bank could partner with commercial banks to make these assets available to the public.

Just like traditional cash, CBDCs will help to make money transfers much more accessible. Their proponents have also touted them as being less expensive.

Phasing out paper cash

Governments could make CBDCs available to the public gradually. This process could come through a tiered method, where the CBDCs go into circulation in gradual phases. This way, the government will find it easier to take out paper money from circulation.

Consequently, the government will be able to adjust CBDC interest rates without facing any constraints.

Effective price stability

Incorporating CBDCs into a firm monetary framework will make it easier to maintain the CBDCs value. This is especially true for long-term stability. In addition, a proper framework will encourage the transparent and effective movement of money to benefit the CBDC.

Payment Processing is the Main Goal

There have been many reasons for developing CBDCs. However, perhaps most pressing is the need for sufficient payments.

Today, the global standard for cross-border transactions is the SWIFT network. But, it faces a significant drawback. Worldwide adoption has put a strain on this network, making it almost impossible to access adequate payments. This is why it takes days to send money abroad, and the process itself costs a lot of money.

Cryptocurrencies have proven to be a much better alternative. With cryptocurrencies, you can send money abroad and receive cash in a matter of minutes. You also don’t have to spend so much, so you get the best of both worlds.

A CBDC will try to replicate this. Many of the developments we’re seeing have the same patterns as cryptocurrencies. So, CBDCs should be able to facilitate high-speed, low-cost cross-border payments.

Global cross-border transactions run into the trillions of dollars quickly. Data shows that it should reach $26 trillion by next year. By making the process faster and cheaper, CBDCs could be bringing a paradigm shift to how we send money.

The Problem of Centralization

While CBDC development is a great thing, it isn’t without its drawbacks. One such problem is that of centralization. Today, most traditional cryptocurrencies are successful because they are decentralized. They run on blockchain platforms and can process transactions fast. But, many governments have balked against this trend.

Several governments continue to push for the centralized approach, where they hold all data. Understandably, governments want to keep transactional data on CBDCs. They want to know who is violating financial laws and sending illegal money. But, centralization is part of what got us here.

There have been several instances of hacks on banks and other financial institutions. By taking the centralized approach, governments are making themselves the target of large-scale hacks.

Internet Infrastructure is Another Challenge

One of the primary benefits of CBDCs is the opportunity to bank the unbanked. This is especially true for developing economies. For instance, the percentage of unbanked people in Africa is currently about 57 percent.

In many developed economies, issues like infrastructure challenges have made it almost impossible to access banking systems. CBDCs can bring a change to that, allowing people to access financial services. Instead of having to travel great distances to get to a bank, you can have one right in your home.

But, a significant challenge to this is the underdeveloped internet infrastructure. Many of these developing economies still have issues with internet inclusiveness. Retake Africa, where Kenya has the highest internet penetration rate with 85 percent. Some countries on the continent have internet penetration rates as low as 10 percent.