Digital Currencies and Central Banking: The Future of Money
Vihaan Bakshi, Research Executive
Introduction
What is a currency? It is essentially a measure and store of value issued by a country’s central bank and has the legal backing of the government. A central bank digital currency (CBDC) is the same, except in a digital form. It is similar in concept to cryptocurrencies. However, the key difference is that the central bank fixes the value of a CBDC equal to the country’s fiat money, ensuring stable value and fewer fluctuations. Security, reduced transaction costs and less tax evasion or money laundering are only some of the benefits.
Until now, cash has dominated as a form of money. However, with the growing trend of digitisation, digital cash in the form of CBDCs is garnering attention. CBDCs are growing in popularity because of the increasing reluctance of people to hold cash in their wallets. Cashless payments are taking over the world, and they can be seen in many forms, one of which is CBDCs.
Thus far, there are three main types of CBDCs: Wholesale (similar to holding reserves in a bank and used primarily by financial institutions), Retail (digital government-backed currencies that are mainly used by businesses or consumers), and Hybrid (a mix of both retail and wholesale).
The Global Surge in Cashless Payments
A country’s economy and financial systems are highly dependent on the makeup of its payments system. Improvements in payment systems are highly beneficial and hugely mitigate risks while promoting financial inclusivity. Cashless payments are at the forefront of this industry due to technological advancements over the last decade. Their rise in number can be seen on a global scale, with more safety and efficiency. According to Ardic & Dashi (2024), between 2017 and 2020, the number of cashless transactions per person every year globally rose from 91 to 135. A key factor behind this growth has been the strengthening of the legal framework of payment systems. Similarly, more jurisdictions have enabled increased transparency for remittance transactions. Capgemini Research Institute also concluded that non-cash transactions grew by 17% from 2022 to 2023.
India is one of the countries which has progressed rapidly in leveraging technology for economic growth. The Unified Payments Interface (UPI) made history by processing over 16 billion financial transactions in October 2024. UPI has revolutionised the digital payments apparatus in India as it offers convenience and privacy for users through 24/7 transactions and single-click payments. It can integrate a plethora of banking services into one app, without the need to share sensitive details. It has been extremely beneficial for small businesses and workers due to its ease of use in handling transactions. The Covid-19 pandemic certainly helped as people began to look for contactless methods to conduct payments rather than using cash. Although it started in India, UPI has been adopted by seven other nations which include Singapore, UAE, Sri Lanka, Bhutan, Nepal, France and Mauritius.
However, in most of Europe and North America, other forms of digital payments have taken over. Credit and debit cards can easily be connected to mobile phones through digital wallets like Apple Pay and Google Wallet. Some emerging nations are still slow to get rid of cash. Nations in Africa and South America still use cash as their payment method, even though the credit and debit card mechanisms are well established. Nonetheless, the widespread use of smartphones has led to this expansion of e-commerce. The Asia-Pacific region leads in this category, with North America and Europe close behind.
CBDC Development Across Regions
Thus, digital money already exists in a different form. CBDCs simply seem to punch it up a notch. Digital currencies are a form of token-based digital money, and tokenisation, primarily achieved through blockchain technology. Blockchain is a decentralised public ledger that maintains an ever-growing list of ordered records using cryptography links. It serves as the foundation for various forms of money like cryptocurrencies, stablecoins, and CBDCs. 134 nations have started experimenting with digital versions of their currencies.
North America and Europe
Almost the entirety of North America is in the development phase of its CBDCs. The United States seems to be confused as it is participating in a wholesale CBDC project with some other major central banks. Yet, there is a bill in their Senate prohibiting the issuance of a retail CBDC. They are currently only pushing for bank-to-bank transactions with a digital dollar, or in other terms, a wholesale CBDC. The Bank of Canada has conducted extensive research on a possible digital Canadian dollar. However, it has also been one of the most cautious banks regarding CBDCs and recently announced that it will “scale back” work. Rather, they are focusing on policy development in consideration of the entire payment landscape of their economy.
Unlike the USA, the European Central Bank is currently in its preparation phase for a retail CBDC, building on its findings and conclusions about digital currencies. It has begun pilot testing and the ECB is conducting experiments to ensure the digital euro’s quality and standard. Through this, they also hope to boost their payments industry’s competitiveness as the CBDC will reduce dependence on foreign competitors.
Asia
Asia plays a principal role in advancing CBDCs. The Bank of Thailand and the Hong Kong Monetary Authority started Project mBridge, the goal of which is to create a multi-CBDC platform for rapid international settlements and have now welcomed the Central Bank of the United Arab Emirates, the People’s Bank of China and the Bank for International Settlements. They aim to use blockchain to internationalise the Yuan and have made the move from a pilot programme to a product with minimal functionalities.
China itself has taken long strides in this field. It started by using the digital yuan as a retail CBDC in public transportation networks and even extended it to foreign attendees at the 2022 Winter Olympics hosted in Beijing. Although it is part of a pilot project, China’s digital yuan is meant for large-scale implementation and is a part of the economy’s monetary supply. In an economy where cryptocurrency transactions are banned, this CBDC can be seen as a “monetary substitution” to create a domestic payment option for the Chinese. Singapore also started a wholesale CBDC pilot project in 2023. Although the Monetary Authority of Singapore previously saw no need for retail and wholesale CBDCs, it launched Project Ubin+ to bolster the country’s digital currency infrastructure, especially for international transactions.
Africa and Latin America
Nigeria was one of the first countries to launch a CBDC - the eNaira. It was meant to complement their physical currency rather than completely replace it. However, it did not pick up much due to a lack of trust in the government, weak technological infrastructure and privacy concerns. Ghana and South Africa are running pilot projects for hybrid and wholesale CBDCs, respectively, whereas most other countries are still in the research phase.
According to the International Monetary Fund, Latin America and the Caribbean region are the foremost in terms of adoption of digital money. The nations have taken great steps to introduce CBDCs so as to increase financial inclusion and lower costs for cross-border transactions. Jamaica and the Bahamas have already started operating their digital currencies - the JAM-DEX (hybrid) and the Sand Dollar (retail), respectively. Brazil is close behind with its goal of tokenising assets like stocks or real estate into their digital versions.
Potential Benefits and Risks
All these nations are spurred on by the benefits they may gain from modernising their financial systems by adding CBDCs. These digital currencies help cut transaction costs and times as they eradicate the need for separate money transfer services. With fewer intermediaries comes greater transparency, which reduces the risk of systemic failure in such services. Transactions on a global scale can be made in a few seconds, rather than the norm of a few days. This would, in turn, promote economic activity and growth. CBDCs also foster financial inclusion by bringing people into the banking system. This can be seen especially in underbanked nations with little access to conventional banking services, such as Nigeria, India and Malawi, with positive outcomes.
On other fronts, CBDCs counteract criminal activity to some extent as well. Digital records allow for the prevention of money laundering and fraudulent activity. On a more economic note, central banks can use digital currencies to sharpen their monetary policies by applying different rates for different CBDC holders. They can directly influence consumption and investment and control inflation or other economic fluctuations by incentivising spending through lower rates for consumers or promoting savings by businesses with higher rates. This will allow for tailored responses to a wide range of economic problems and will be made easier by the presence of a centralised digital currency, which reduces the risk of criminal activities.
Contrarily, CBDCs also open up a world of potential risks. The presence of retail CBDCs would serve as an alternative to bank deposits, which could potentially lead to bank runs. At the very least, it would deprive banks of funding and remove their ability to lend. This risk of bank failure only has one direction: towards financial instability. Using CBDCs may even create rifts between the central bank and private banks. In this case, the central bank might function more like a private one, conducting exercises they are meant to regulate. Additionally, the concentration of all citizens’ data in one database would entice more cyber attacks, running the danger of disregarding data protection and privacy laws in the digital payments landscape.
Conclusion
Central Bank Digital Currencies represent a transformative capability to shape the modernization of global financial systems, with such benefits being enhanced financial inclusion, cost-reducing transaction expenses, and better cross-border payments, but their success and acceptability depend on the specifics of the regional economic, political, and technological scenarios. While China and India showcase what CBDCs have to offer for advancing financial innovation and inclusion, adoption challenges - as exemplified in Nigeria -highlight an emphasis on trust and infrastructure, ultimately revealing that regional patterns will characterize the course for CBDCs, where a 'one size fits all approach' neither proves feasible nor effective. It is thereby in how CBDCs manage the interplay of innovation and local needs within which the role of tomorrow's money will be secured.
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