Although we’re not quite yet at a cashless society, over the past few decades, banknotes and coins have become ever less important to the citizens of countries with advanced economies. Across large swathes of the globe, the ubiquity of credit cards and innovations like Apple Pay and GrabPay has made it easy to go weeks or even months without handling a physical currency bill.
Central bank digital currencies, or CBDCs, may move the world even further away from cash. Simply put, CBDCs are digital-only legal tender issued by one of the world’s central banks.
They’re secure, they have individual identifiers for tracking, and they stand to make the backend processing of money settlement more quick and more efficient.
Widespread interest
By January 2020, the Bank of International Settlements discovered, over 80 per cent of central banks had begun looking into CBDCs. In the Asia Pacific region, progress has been especially swift.
South Korea’s central bank has initiated a pilot programme that will run through the end of 2021, while this month the Monetary Authority of Singapore tested the international settlement capabilities of its digital currency.
Four major Chinese cities are participating in a CBDC pilot programme. As the breadth of interest in this new technology shows, CBDCs are a very big deal.
While CBDCs do not necessarily need to exist on a blockchain, there are countless advantages in doing so. For example, the decentralised nature of blockchain increases the security of the network, making CBDCs less susceptible to cyber attacks.
Climate-conscious innovation
However, blockchains (specifically “Proof-of-Work” blockchains like Bitcoin and Ethereum) have come under heavy scrutiny for their impact on the planet, largely as a result of the energy requirements necessary to run.
Bitcoin and most other cryptocurrencies are “mined” by computer rigs seeking to meet the requirements of this “Proof-of-Work” algorithm.
Although bitcoin mining takes place in long lines of server racks, rather than in pits sunk deep into the earth, mining a bitcoin can be just as environmentally destructive as mining gold or coal. In 2019, bitcoin mining used up as much energy as the Netherlands.
That’s why it’s vital that any CDBC implementation avoid the catastrophic environmental damage that many cryptocurrencies inflict.
Assessing the energy-efficiency of a blockchain’s design is absolutely critical when it comes to deploying CBDCs as it would have a long term impact on the planet. Central banks must be cognizant of the fact that not all blockchains are built the same, and operate on different levels of efficiency.
Proof-of-stake blockchains like Tezos for example, require significantly less energy to run and are therefore the more environmentally-friendly choice.
Seamless and painless
Proponents of cryptocurrencies such as Bitcoin allege that they’ve discovered the future of money, but anyone trying to operate in crypto quickly runs into problems, including slow transaction processing, extreme volatility, and illiquidity.
It is rare to pay for a good or service with cryptocurrency; in almost all cases, you must first convert your digital holdings into a traditional currency. And that’s getting harder every day.
Also Read: What does the future of CBDCs actually look like and why does it matter?
By contrast, the experience of using a CBDC will be seamless for the end-user, hardly different from using one of today’s card- or phone-based payment services. That’s because we’re already transacting in central bank currencies; a digital central bank currency introduces new efficiencies to transactions, but the money is backed by the same institution that issued the physical bills that once filled your wallet.
Safer societies
Central banks serve an essential role in safeguarding their countries’ economies, but their decision-makers need more and better data for a twenty-first-century world that is ever more connected and ever more complicated. Because CBDCs can be tracked, bank analysts will have better sense of economic trends.
They’ll find themselves better-placed to stimulate growth with new policies, and they’ll receive early alerts about which segments of a market may be overheating. Major decisions such as interest rate adjustments will be more obviously justified; the monetary system will grow more trustworthy.
Central bank digital currencies also make the anti-money-laundering and know-your-customer (AML/KYC) process easier, potentially leading to a global reduction in fraud and financial malfeasance.
Because CBDCs would operate more quickly than traditional fiat exchanges, countries would have a powerful tool for quickly stopping the spread of financial contagion.
Finally, CBDCs deepen countries’ liquidity pools, thereby allowing higher economic activity for the growth and benefit of participating societies.
Privacy drawbacks?
Tracking currency has obvious benefits, but it would appear to have privacy downsides as well. When the European Central Bank surveyed potential users about a digital euro, privacy was the most common concern raised. Is it really the case that a CBDC will erode privacy?
The first point to consider is that older forms of physical currency are surprisingly traceable. While it’s common to say that cash payments are “untraceable,” a physical note invariably has a serial number on it.
Second, as Bank of England fintech director Tom Mutton testified and Finextra reported, “the bank has no commercial incentive to gather user data; choices can be made within a system to protect data; and technologies, such as zero-knowledge proofs and digital identity frameworks, could enhance transparency while still increasing security and privacy.”
In short, CBDCs are transparent enough to deter financial crime while being sufficiently opaque to preserve user privacy.
Central bank digital currencies’ day may not have come quite yet, but it’s clear that the 2020s will be their decade. As I write this, several APAC countries, including Singapore, South Korea, Vietnam, and China, are among the world’s leaders in developing, testing, and implementing digital currencies.
That willingness to innovate, experiment, and think big will pay substantial dividends down the line. If the implementation of CBDCs continues, the people of the Asia-Pacific region will have a brighter financial future.
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