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CBDCs are gaining traction in 2023 and dominating conversations in various crypto-related circles, as observed at World Economic Forum 2023. Not everyone is a fan, though!
There are two camps, one led by the Central Banks and other global financial organizations, such as the IMF, the World Bank, and more. The other comprises the majority of crypto enthusiasts with varied levels of blockchain tech affinity.
The CBDC detractors see the Central Bank Digital Currencies as another way governments maintain their control over the financial lives of the masses. They believe CBDCs will grant undue surveillance access to the governments, enabling them to prevent anyone from accessing the financial infrastructure.
If we go by what Central Banks and their ilks preach about CBDCs, which they see as a legitimate alternative to cryptocurrencies, some may get the impression that CBDCs are flawless and the rightful currency to power the digital economy of the future.
The question is, which of these two viewpoints is correct? Both sides have some valid points. We are not taking any sides. For Shyft, what matters most is the user. This is why Shyft’s goal is to ensure that the user experience remains intact while compliance requirements are met.
You may be wondering why all of a sudden, Shyft is talking about CBDCs. Well, as already seen in China, CBDCs can support smart contracts. Once CBDCs start gaining traction and the support of Central Banks worldwide, DApps will also support them along with cryptocurrencies.
At that point, we expect the FATF to extend the Travel Rule to CBDCs. Similarly, countries may enforce their own set of AML & CFT-focused rules and regulations on CBDC transactions.
That's where Shyft Veriscope comes into the picture, as VASPs will continue using it for Travel Rule compliance, whether it is for crypto transactions or CBDCs.
For those unfamiliar with CBDC, it stands for Central Bank Digital Currencies. As a concept, CBDCs have become a hot topic globally in a short time.
As per Atlantic Council’s CBDC tracker data, only 35 countries were considering a CBDC in May 2020, which has grown to 114 countries, covering 95% of the global GDP today.
Jamaica is the latest country to launch its CBDC, the JAM-DEX. In terms of absolute user numbers, China’s CBDC pilot is leading by a considerable margin, as it has already reached a population as high as 260 million.
A Central Bank Digital Currency (CBDC) is the digital form of a country’s fiat currency. China’s CBDC, for instance, is called Digital Yuan.
The United States CBDC goes by the name of Digital Dollar. It is also common to denote a country’s digital currency by adding the prefix "e" before a country’s fiat money. For instance, Uruguay’s CBDC is e-Peso, Sweden’s CBDC goes by the name of e-Krona, etc.
Worldwide, CBDCs are known for some of their common features. Everywhere, it is a sovereign currency that Central Banks issue, and it appears on the Central Bank’s balance sheet as a liability. The central bank issues Central Bank Digital Currencies in line with the country’s monetary and fiscal policy.
Since a country’s central bank releases its CBDC, it is a legal tender, a valid payment medium, and a store of value for all citizens, enterprises, and agencies using it. There is no bar against converting CBDCs with commercial banks’ money and cash. CBDCs are a fungible legal tender. One may not need to have a bank account to hold Central Bank Digital Currencies.
There are several reasons why a Central Bank will be keen to bring out a digital currency for the country. The estimates suggest it lowers the cost of the issuance of money flows and transactions and helps deal with many limitations of the paper currency. A digital currency also helps solve the challenges that come with cross-border payments.
CBDCs reduce the cost associated with physical currency management. It helps reduce cash dependency in an economy by encouraging competition, efficiency, and payment innovation.
Central Bank Digital Currencies have their advantages over other digital payment systems. Since it is a sovereign currency endorsed by the Central Bank of the country, it seamlessly ensures settlement finality, reducing settlement risks in the system by a large margin. It supports financial inclusion. And as already seen, not only may it not require a bank account to hold it, but it is also an affordable, accessible, convenient, efficient, safe, and secure system.
To date, eleven countries have already launched their Central Bank Digital Currencies. These countries include Nigeria, Jamaica, the Bahamas, and the Eastern Caribbean (Anguilla, Antigua and Barbuda, Commonwealth of Dominica, Grenada, Montserrat, St Kitts and Nevis, Saint Lucia, and St Vincent and the Grenadines).
In seventeen countries, Central Bank Digital Currencies are in a pilot phase. These countries include Ghana, South Africa, Australia, Saudi Arabia, Sweden, Ukraine, Kazakhstan, etc.
There are 33 countries where CBDCs are in their development phase. Examples of such countries include the United Kingdom, Norway, Tunisia, Turkey, Bahrain, Bhutan, Mauritius, etc. And CBDC research is ongoing in 39 countries, which includes Mexico, Colombia, Paraguay, Morocco, Hungary, the Czech Republic, etc.
There are 15 countries in the world where CBDC projects are on pause. These countries include the likes of Iceland, Denmark, Egypt, Kuwait, Argentina, Uruguay, etc.
So far, two countries globally have canceled their CBDC projects, namely Ecuador and Senegal.
There are two types of broadly accepted CBDCs: the general purpose or retail CBDCs, usually known as CBDC-R, and wholesale CBDCs, denoted as CBDC-W. There could be other CBDC classifications as well.
For instance, if we go by the models for issuance and management, CBDCs could be Direct, Indirect, or Hybrid. By form, CBDCs could be token-based or account-based. By instrument design, Central Bank Digital Currencies can be remunerated or non-remunerated. CBDCs can also vary as per their degree of anonymity.
While all these categories exist, one classification that matters the most, as it directly deals with use cases in real life, is the classification by issuance.
Retail Central Bank Digital Currencies are for use by all private sector and non-financial consumers and businesses. The Wholesale CBDC is meant for restricted access and use by select financial institutions.
Put simply, the Retail CBDCs are the electronic version of physical cash, which find their use in retail transactions. The Wholesale Central Bank Digital Currencies facilitate interbank transfers and related wholesale transactions.
Direct model Central Bank Digital Currencies are ones where Central Banks are responsible for managing all aspects of the CBDC system. In an Indirect Model CBDC, other intermediaries, such as banks and other service providers, play a role. The indirect model is where the banks manage everything, including distribution, account-keeping, KYC adherence, anti-money laundering checks, transaction verification, etc.
A token-based CBDC is a bearer instrument, which implies that the holder of the token at a given point in time is its presumed owner. An account-based CBDC needs maintenance of the record of balances and transactions of all holders of the CBDC, which denotes the ownership of the monetary balances.
Remunerated Central Bank Digital Currencies are interest-bearing, which means this kind of CBDC earns interest. The concept of paying interest will likely make the CBDC more attractive as a financial instrument.
Non-Remunerated CBDCs, on the other hand, implies non-interest-bearing instruments. i.e., Holders of these CBDCs will not earn interest. Presumably, in the case of these CBDCs, the public would have less incentive to switch from holding bank deposits to CBDCs. It would also mean a limited effect of banking disintermediation.
Finally, ensuring anonymity in a digital currency is difficult - since digital transactions leave some trace. For retail Central Bank Digital Currencies, reasonable anonymity for small-value transactions could be a desired feature.
While both can be thought of as digital money or digital currencies, and both run on the foundation of blockchain technology, the two are different. Cryptocurrencies are independent digital currencies that run on decentralization principles, devoid of any predetermined value or backing. CBDCs, on the other hand, enjoy the backing of Central Banks worldwide.
Cryptocurrencies leverage a permissionless open network. CBDCs typically use a private blockchain network that requires prior authorization.
We have already discussed the notion of anonymity and how it applies to Central Bank Digital Currencies. CBDCs, usually linked to a user’s bank account, are not anonymous. When users carry out cryptocurrency transactions, they remain anonymous.
It is easier to scale Central Bank Digital Currencies since a central authority manages them. Changes, upgrades, and modifications in the cryptocurrency network, on the other hand, require consensus among all nodes in the network. Nodes disagreeing on any agenda that impacts scalability could deter the crypto network's growth.
Speaking of the impact of CBDCs on cryptocurrencies, Thomas Borrel, COO of Shyft Network, said: “CBDCs are a contentious use of blockchain technology as they could improve our established financial system, but also materially affect individuals' right to privacy. Implementation and governance are likely key factors on whether CBDCs will succeed in pulling away even a small percentage of crypto curious and crypto enthusiasts.”
The Bahamas launched its CBDC in October 2020. Known as the Sand Dollar, the project received great praise from globally revered firms like PriceWaterhouseCoopers, which described it as the “World’s Most Mature CBDC.”
The purpose of the Sand Dollar was to increase financial inclusion by enhancing access to digital payments. However, many experts believe it failed to meet its commitments. Two years after its launch, there were $338,908 Sand Dollars in circulation, implying a per capita circulation of around 86 cents. It was insignificant compared to a per capita circulation of $78 in coins and $1,287 in Bahamian notes.
There are many Central Bank Digital Currencies that offer a host of benefits. For instance, the Digital Yuan app in China allows users to transfer money from their bank accounts to top up a digital wallet. Subsequently, the users can choose which apps to use the Digital Yuan for. It is as convenient as using other forms of popular online payment platforms in the country, such as WeChat pay or Alipay.
A digital US Dollar by the federal reserve bank in the United States can enhance policy efficacy by directly reaching the targeted beneficiaries of government assistance and stimulus payments.
However, how far the committed benefits of CBDCs would be able to aid our financial systems is something that still requires more assessment time.
From South America to South Korea, CBDCs are everywhere. From the International Monetary Fund to the World Economic Forum, every major global authority discusses it with vigor and sincerity. In varied use cases, from fueling economic growth through enhanced inclusion to facilitating international settlements, Central Bank Digital Currencies have become a part of many countries’ monetary policies.
Many experts believe it can radically improve a monetary policy’s effectiveness by strengthening the pass-through of the central bank’s policy rate to the broader structure of interest rates in the financial system. CBDCs can also help counter the credit and liquidity risks from exposures to either private issuers of digital tokens or from the lack of an issuer.
In September 2022, the White House published a report that outlined the country’s expectations, stemming from the efforts of researching Central Bank Digital Currencies at a large scale in the U.S. The report, titled ‘Technical Possibilities for a U.S. Central Bank Digital Currency,’ deposed full faith in the future potential of CBDCs. It cited President Biden’s vision for America, and that vision of possibilities applies to CBDCs across all countries that have undertaken it. The report said, “a “digital dollar” may seem far-fetched, but modern technology could make it a real possibility.”
The same holds for all CBDC-aspiring economies.
