Day by day, various businesses, goods and services are becoming increasingly digital, slowly leaving behind the use of paper. So what does this mean for the mediums of exchange we use on a daily basis to pay for these goods?
The future of digital currency is closer than you may expect…
In April 2021, Rishi Sunak revealed plans with other G7 countries to launch retail Central Bank Digital currencies (CBDCs) as Sunak said a joint Treasury-Bank of England taskforce has formed as part of a range of measures designed to help boost the UK after it’s separation from Europe. A main reason for this was to keep Britain in front in terms of innovation and due to the decline in the usage of cash and the values of many crypto currencies such as bitcoin soaring in value (Bitcoin reaching its peak of $63,000 in April 2021).
Currently in 2023 we know that the Bank of England are still in the process of creating the infrastructure for a digital pound as they are collaborating with block chain companies to help with the possibility of launch this digital currency. But this is occurring despite Andrew Bailey, the governor for the Bank of England being against this idea as he said, “I think it’s an open question whether a wholesale digital central bank currency is needed because we’ve got a wholesale central bank money settlement system with a major upgrade,” and “We have to be very clear what problem we are trying to solve here before we get carried away by the technology and the idea.”, at a Treasury Select Committee.
But for the readers that may not understand the concept of CBDCs: What are they? What are the advantages as well as disadvantages to a digital pound being released? And what would happen to the existence of tangible cash?
What are CBDCs and what is the different between it and cryptocurrencies?
A Central Bank Digital Currency is a digital token issued by a central bank, such as the Bank of England, used to represent a country’s fiat currency. This allows there to be a direct link between the central bank and consumers eliminating the use of commercial banks. There are two types of CBDCs- A wholesale CBDC and a retail CBDC. A wholesale CBDC is mainly used by financial institutions such as banks (having a similar function to holding reserves) while retail CBDCs are used by consumers and producers, similar to formal forms of money. Both wholesale and retail CBDCs and co-exist on one financial ecosystem.
The main difference between a cryptocurrency and a CBDC is that a CBDC is centralised (where one main authority, such as a central bank, has full control over the currency) while cryptocurrencies such as bitcoin are decentralised (meaning no group or person owns or controls the currency even the developers themselves). Both types of currencies are backed by in world assets and both use block chain technology (a block chain is a distributed database or ledger that is shared among the nodes of a computer network). Majority of CBDCs will use permissioned block chain technology (where the block chain is not publicly available so access is required to join and perform actions in the block chain). The value of both currencies mainly changes in value due to market factors such as the supply of these tokens. The Bank of England's CBDC lead Katie Fortune said that crypto and CBDCs could potentially work in an ecosystem- as there could be different digital currencies that can exist, such as physical cash and bank savings working together.
What are the advantages of CBDCs?
The use of digital money could make the financial system more efficient. For example a possible advantage is that the monetary policy could become more simple and efficient in implementation. CBDCs allow there to be a direct line of transaction between the Bank of England and consumers and businesses, meaning new contractionary and tightening policies can be created as flows of money in the banking system are streamlined, giving a direct link between the central bank and citizens.
Another use is that it can allow governments to easily distribute social benefits to their citizens as money can be sent straight into a CBDC account and can help the government to easily collect tax revenue. If the system of CBDCs worked on a global scale, this can allow countries to easily send remittances to one another, reducing the costs of exchanging the currency.
The already growing fin-tech sector can also benefit from this switch to digital currency as they are likely to be involved in the development and maintenance of this sector.
Finally the elimination of tangible cash and the use of CBDCs can help heavily reduce criminal activity as transactions can be easily tracked and monitored by the central bank. This will also help reduce the theft of money as CBDCs can be tracked and has one named owner between every transaction while tangible money does not provide this benefit.
But what are the disadvantages?
All the given advantages may help justify the use of CBDCs but we also need to consider the possible negative effects that this can bring, involving ethical problems. CBDCs remove privacy you receive when using cash. The central bank can monitor and track every transaction a citizen has made as even if ‘private ledgers’ are available when CBDCs launch, a central bank will still be able to monitor the transactions. With the elimination of physical money, this can cause unethical monetary policies to be created. In China, with their digital yen, they are testing the use of expiration dates on their digital currency which means that consumers will have to spend their money before it disappears, as a potential monetary policy to encourage spending. It can also become increasingly easier for the central bank to add a higher volume of tokens into the system as a method of quantitative easing. Loans and mortgages could also become a monopoly where only the central bank provides loans at an interest rate with little flexibility.
All these disadvantages can cause ethical dilemmas, as if there is political corruption or bias, this can cause injustice in the country as the authority over this currency can easily remove assets from accounts without permission from the owner of the account. Countries such as Nigeria- where human right regulations are violated on a regular basis- that have already implemented their currency (eNaira) allows more political corruption and human right violations to occur.
We also need to consider the cybersecurity of this CBDCs system. If an economy becomes reliant on a system that may have potential weaknesses in term of cybersecurity, if this system is compromised, this could potentially ruin an economy if data regarding all these transactions are lost or leaked. Finally, we should also consider the future of the traditional finance sector and the potential losses in jobs that could be created as we step away from commercial banking companies and other financial services. There could be jobs created through this change through the fintech industry but we also need to consider if these workers would be able to transfer their skills into a new job role. This is already backed by many commercial banks reducing the number of physical branches they operate, as a majority of banking is already moving online.
Summary:
It should be noted that the majority of points for and against the use of CBDCs are made from assuming that CBDCs would be the only currency used in the banking system. A banking system can exist with multiple currencies such as CBDCs, crypto and physical cash, which can minimalize some of the given disadvantages but we should still consider what would happen in a potential future where digital money is the only form of currency, as we see the global economy become more and more digital as well as political agendas varying in different countries.
Author's opinions:
I believe that CBDCs give an interesting perspective into the future of digital money but as Andrew Bailey said we shouldn’t rush into making a new currency just for innovation purposes, we should look at the disadvantages of the current medium of exchanges we use to see if it is worthwhile switching to a digital currency. As noted before, a CBDCs could just be another gateway to using money but if this becomes the sole type of currency used, this can quickly cause political bias to influence consumers and the economy to achieve macroeconomic or political goals. Overall I believe that CBDCs could be a possibility in the future to streamline the banking industry but it is not needed in these current years due to sufficient types of currencies being available.
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