June 24, 2024

Australia is the latest country to trial a central bank digital currency (CBDC). As more countries transition away from paper and coins, CBDCs have gained prominence.

But CBDCs come with their own set of challenges. If they’re not designed carefully, CBDCs may have unexpected ramifications on monetary policy – this article explores these concerns further.

1. They Will Be a Tool for Central Banks

Central banks face complex monetary issues that present both opportunities and challenges. While their goal may be to promote low-cost payments inclusive to all sectors while encouraging innovation and safeguarding privacy, these goals could be undermined by new payments systems or private money replacing central bank currency as the unit of account in transactions – undermining their capacity to conduct monetary policy effectively or act as lender of last resort.

To combat this trend, over 100 countries are exploring CBDCs – digital versions of national currencies that can be used to make or receive payments – as a solution. McKinsey research indicates that CBDCs could help increase financial inclusion by making money easier and safer to use; but they could also bring new risks, including cybersecurity threats and theft. Therefore, central banks must carefully craft their CBDC designs – this requires new decision-making processes, change management capabilities, as well as talent experienced at creating partnerships.

2. They Will Change the Way Central Banks Operate

Central banks that transition to digitize money will face challenges that could hinder voluntary adoption of this change. First, digitalization makes money traceable – potentially jeopardizing privacy while creating tax obligations – while there’s also security. Whereas individual banks rely solely on themselves for security measures, their current systems leave them susceptible to breaches that require costly localized security solutions; CBDCs would have access to national cyber expertise which should make for stronger cybersecurity measures.

CBDCs are liabilities directly held by central banks, unlike paper dollars or yuan held by banks that hold them. This could alter the basic model of how money works and make banks compete harder against one another as their brand reputation for safe custody of cash won’t matter anymore, according to Deloitte. Furthermore, this could hinder central banks in tracking global financial flows which could compromise national security objectives.

3. They Will Be a Source of Competition for Banks

Central banks can benefit from CBDCs for various reasons. Perhaps they’d like to address the declining use of cash and growing interest in privately issued digital assets by offering a public alternative, introduce competition into domestic payments markets or enhance monetary policy effectiveness by gathering real-time data on money flows.

CBDCs may be deployed using different technologies, including blockchain. Individuals could hold them directly in a digital wallet or use intermediaries such as banks or non-bank FinTechs to distribute and hold the tokens. CBDCs could then be used to pay for goods and services without bank accounts – helping reduce financial inclusion costs in emerging markets.

Toni Ahnert (Economist at ECB), Katrin Assenmacher (Head of Division for Monetary Policy Department), Peter Hoffmann, Agnese Leonello, Cyril Monnet and Davide Porcellacchia explore potential economic benefits associated with CBDCs in this post based on their working paper: The Economic of Central Bank Digital Currencies by Ahnert Assenmacher Leonello Monnet & Porcellacchia (2022a). Click here to access their full paper.

4. They Will Be a Means of Payment

How CBDC fits into peoples lives will ultimately determine whether they utilize it. Monetary authorities should strive to make accessing money easier, safer and cheaper – providing unbanked people with new ways of paying; increasing financial inclusion by giving unbanked people another payment mechanism; encouraging competition and resilience within domestic payments systems (by cutting the cost of sending and receiving payments); as well as decreasing systemic risk by decreasing digital concentration and convertibility risks on tech platform balance sheets.

CBDC will also help lower demand for physical cash, which is expensive and difficult to transport and store. This could be especially important during crises like the COVID-19 pandemic or countries with higher crime levels since CBDC transactions can be traced and anonymous.

CBDCs must compete with private money, which millions of Americans can access easily via online checking accounts and mobile payment apps. Monetary authorities will have to work diligently in integrating CBDCs into banking systems in ways that protect privacy, consumer protection and security.

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