What are Central Bank Digital Currencies?

Central Bank Digital Currencies (CBDCs) are digital versions of a country’s fiat currency, issued and backed by the central bank. While many central banks around the world are exploring the potential use of CBDCs, only a few countries have actually launched pilot programs or full-scale implementations of CBDCs.

One of the first countries to launch a CBDC is the People’s Republic of China. In October 2020, the People’s Bank of China (PBOC) launched a pilot program for its digital currency, the Digital Currency Electronic Payment (DCEP), in four cities: Suzhou, Chengdu, Shenzhen, and Chengdu. The DCEP is designed to function like physical cash and can be used for P2P transactions, but it can also be transferred and stored electronically. The PBOC has stated that the goal of the DCEP is to improve the efficiency of the financial system, increase financial inclusion, and reduce the risk of financial crime.

Another country that has launched a CBDC is the Bahamas. In October 2020, the Central Bank of the Bahamas launched the Sand Dollar, a digital version of the Bahamian dollar that can be used for P2P transactions. The Sand Dollar is designed to increase financial inclusion and improve the efficiency of financial transactions in the Bahamas, particularly in the remote islands where access to traditional financial services is limited.

Other countries that are currently exploring or piloting CBDCs include Sweden, the European Union, the United States and lately Egypt. The Swedish central bank, the Riksbank, has been studying the potential use of a CBDC, known as the e-krona, since 2017. In 2020, the Riksbank announced that it was launching a pilot program to test the technical feasibility of the e-krona. The European Central Bank is also exploring the potential use of a CBDC, known as the digital euro, and is currently conducting a public consultation on the topic. In the United States, the Federal Reserve has also expressed interest in the potential use of a CBDC and has launched a research program to study the topic.

One risk of CBDCs is the potential for reduced demand for commercial bank deposits. If individuals and businesses start holding CBDCs instead of traditional bank deposits, this could lead to a decrease in the demand for commercial bank deposits, which could in turn reduce the profitability of banks and impact their ability to lend. This could have negative consequences for the stability of the financial system and the economy as a whole.

Another risk of CBDCs is the potential for their use in illicit activities, such as money laundering and financing terrorism. CBDCs, like any other digital currency, can be transferred and stored electronically, making it easier for individuals to engage in such activities without being detected. It is important for central banks and regulatory authorities to put in place appropriate safeguards to prevent the use of CBDCs for illicit purposes.

A third risk of CBDCs is the potential for cybersecurity attacks. As CBDCs are digital currencies, they are vulnerable to cyber attacks, which could compromise the security and integrity of the financial system. It is important for central banks to have robust cybersecurity measures in place to protect against such attacks.

Overall, while CBDCs are still in the early stages of development and adoption, they have the potential to bring numerous benefits, such as increasing financial inclusion and improving the efficiency of the financial system. It is likely that more countries will join the list of those using CBDCs in the future as central banks continue to explore the potential benefits and challenges of these digital currencies.