Digital Currency for the Digital Age

In a new joint report submitted by the world’s three biggest financial authorities—the International Monetary Fund (IMF), the World Bank, and the Bank of International Settlements (BIS)—to the Group of 20 (G20), a group composed of finance ministers and central bank governors from 19 of the world’s largest economies, it has been proposed that a cross-border network of central bank digital currencies (CBDCs) could prove to be hugely beneficial to the global economy. However, this could only be attained through efficient integration of technology and proactive cooperation among the international community.

In the report, the world’s financial triumvirate highlighted the problems and difficulties often faced by the current system when it comes to cross-border payments, a process often hampered by long transaction delays and high costs brought by a large number of middlemen operating across various time zones to complete corresponding banking processes.

Apart from the high cost and delays, cross-border transactions are often obscure and hard to trace, which becomes a problem for Anti-Money Laundering (AML) and combating the financing of terrorism (CFT) implementation.

Besides underscoring the complications often faced by the present system regarding cross-border payments, the report also presented the benefits that the adoption of Centraal Bank Digital Currency (CBDC) could potentially bring to global financial dealings, as well as the drawbacks that it could possibly encounter. Listed among these drawbacks is the fact that countries would have to deal with sudden capital flow reversals due to more frictionless cross-border flows. This in turn could have an impact on a country’s ability to govern its exchange rates.

Moreover, pushing for the implementation of CBDC networks for cross-border transactions would require high levels of international cooperation in order to ensure uniformity of design choices, coordinate strategies, and achieve a degree of structural integration and standardized practices that aim to alleviate the potential risks posed by the issuance of CBDCs.

The ABCs of CBDCs

But what exactly is a central bank digital currency? CBDCs, as the name suggests is a digital version of a country’s central bank’s fiat currency. These digital currencies would be issued and regulated by the issuing country’s monetary governing authority.

CBDCs came under the spotlight in 2020, with the Bahamas’ introduction of the Sand Dollar, the digital version of the country’s national currency and the world’s first CBDC. The Sand Dollar holds the same value as the Bahamian dollar.

Since its entry into the consciousness of various national governments and central banks, different countries have started to study the concept of a central bank digital currency. Among the countries that have started to explore the possibilities offered by CBDCs is the United States, which had begun to look into the viability of having a digital dollar. Other countries, such as China and South Korea have already begun pilot tests with their respective country’s demo CBDCs.

The surge in the interest of various governments in the application of central bank digital currencies in their respective financial dealings could be possibly traced back to 2019. This was the year that libra, the digital currency backed by social media giant Facebook, was unveiled. The unveiling of libra brought governments around the globe to think about whether they should begin to look more seriously into adopting similar technology.

Governments were concerned over the possibility that a currency that was created by a company as well-known and powerful as Facebook could potentially pose a threat against their monopoly of monetary matters. In response, they began exploring in earnest the feasibility of incorporating similar technologies to their existing national monetary systems.

How CBDCs Operate

Would the introduction of central bank digital currencies mean the end of the existing monetary infrastructures? The answer is “not really.” Most of the countries exploring the idea of CBDCs see digital currency as a supplementary form of money, not a replacement for the existing ones.

A number of CBDCs have been based on the same general principles and blockchain technology that the world’s leading digital currency, Bitcoin, uses. Utilizing blockchain technology enables various entities to obtain a copy of a history of transactions so that it is able to circulate and not be controlled by only one entity.

Among the different countries experimenting with the blockchain technology application for CBDCs, Venezuela is considered a pioneer. The country has already launched its own cryptocurrency, the petro, in 2018. Aside from Venezuela, the Chinese government has also succeeded in creating its own digital version of China’s national currency, the yuan, and has begun a trial of its use across several of its cities.

Meanwhile, the United States government has also been collaborating with the Massachusetts Institute of Technology (MIT) to begin working on the concept of a digital dollar.

Central bank digital currencies are still at a very early stage today so it is still too early to tell what features they might have when they get released, if at all.

However, in many cases, CBDCs are like a mixture of Bitcoin and government-issued currencies, with the end product borrowing attributes from both the crypto and government currency. Going into speculations, CBDCs may include distributed ledger technology (DLT). Employing distributed ledger technology allows the financial records of individuals to be stored not just in one central location, but in several different storages managed by separate financial entities.

CBDCs vs. Other Digital Currencies

Although CBDCs share a number of similar characteristics with cryptocurrencies, particularly CBDCs that operate on blockchain technology, the two digital currencies are not alike. One of the key differences between CBDCs and cryptocurrencies is that CDBCs operate using using a permissioned blockchain that allows only selected entities to manage the records of transactions in the blockchain.

This sits in contrast with the permissionless blockchain operation of Bitcoin and other altcoins. In this setup, virtually anyone can run the software and transact within the network without worrying about any central entity.

Weighing in on CBDCs

Working with the information presented above, we can tell that the implementation of CBDCs carries its share of positive qualities and its own complications.

However, despite presenting its own set of complications, implementing cross-border CBDC networks could prove to do more good than harm. As reported by the IMF, World Bank, and the BIS, the creation of CBDCs could have the potential to offer a “clean slate” that would allow the global financial system to greatly improve the efficiency of cross-border payments, and in turn, provide a solution to the AML/CFT implementation dilemma.