A Central Bank Digital Currency (CBDC) is a digital currency that is issued and backed by a country's central bank. CBDCs are designed to function like traditional currencies, but in digital form, using blockchain or distributed ledger technology.
CBDCs are different from cryptocurrencies like Bitcoin, as they are issued and backed by a central authority and are designed to be used as a medium of exchange and store of value, rather than as a speculative investment. CBDCs can be used to make purchases, transfer money, and settle debts, just like physical cash or traditional digital payment systems.
CBDCs are seen as a potential way to increase financial inclusion, reduce transaction costs, and provide greater security and transparency in payments. However, there are also concerns about the potential risks and challenges associated with CBDCs, such as cybersecurity risks, monetary policy implications, and potential impacts on the banking sector.
The concept of CBDCs has gained popularity in recent years; about 90% of the world’s central banks are pursuing CBDC projects. Some, including those in the U.S. and South Africa, are still in the exploratory phase; others are development projects and pilots (the European Union and China), but CBDC solutions are already operable in places like Nigeria, with eNaira.
Still, the Nigerian case study suggests all sorts of restrictions could be imposed on bank accounts when CBDCs are rolled out in North America, Europe, and elsewhere.
Currency experts are concerned with how things played out in Nigeria. To boost mass adoption of the eNaira, the Nigerian government rolled out an impromptu plan to phase out old Naira notes, rendering them worthless.
According to the World Bank, over 55% of the adult population in Nigeria relies on physical cash. The Nigerian government must have known phasing out cash would be a disaster for most people, but they forged ahead anyway.
Withdrawal limits and debit card restrictions were imposed, and capital controls made sending money out of the country almost impossible. Hence a violent scramble to exchange old notes before the government deemed them worthless.
Riots broke out in several locations, and there’s a chance some of the restrictions imposed alongside CBDCs could create social unrest anywhere.
While central bank digital currencies (CBDCs) hold a lot of potential benefits, there are also several risks and challenges that need to be taken into consideration. Here are some of the main risks associated with CBDCs:
- Cybersecurity risks: As with any digital system, CBDCs are vulnerable to cyber attacks, including hacking, fraud, and other types of cybercrime. Central banks would need to implement strong security measures to protect CBDCs from these risks.
- Privacy concerns: CBDCs would involve storing transaction data and personal information on a centralized database, which could potentially pose privacy risks. Central banks would need to develop appropriate measures to protect user privacy while ensuring the integrity of the system.
- Impact on the banking system: CBDCs could potentially disrupt the traditional banking system by allowing people to hold digital currency directly with the central bank, rather than through commercial banks. This could have significant implications for the banking industry and require careful consideration of how to maintain financial stability.
- Monetary policy implications: CBDCs could affect the way monetary policy is conducted, as central banks would need to balance the impact of CBDCs on the money supply and interest rates. This could be particularly challenging in times of economic crisis or instability.
- Technical challenges: The development and implementation of CBDCs would require significant technical expertise, infrastructure, and resources, which could be a challenge for some central banks.
Overall, while CBDCs hold a lot of promise, their development and implementation will need to be carefully considered to ensure that these risks are adequately addressed.
On the date of publication, Andy Mukolo did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
