CBDCs are here, and coming on stronger than ever. Their impact on the world is still unknown, but they could transform finance for good.
Cryptocurrencies and the ever-growing market around them are attracting more attention than ever. Governments are looking for a piece of the action too, and it seems to be slowly arriving in the form of central bank digital currencies, or CBDCs.
Make no mistake, CBDCs aren't cryptocurrencies: These are centrally issued fiat currencies that are managed using a centralized ledger. They may bear a passing resemblance to cryptocurrencies like Bitcoin, and others may think of them as being closely related to stablecoins (cryptocurrency tied to fiat value), but that's where the resemblance ends.
CBDCs basically act like digital cash, a concept that brings with it a number of questions and concerns, and rightfully so. CBDCs have the potential to reshape our entire global economy.
SEE: Cryptocurrency: An insider's guide (free PDF) (TechRepublic)
CBDCs: The basics
Stablecoins, mentioned above, are cryptocurrencies living on a blockchain that have their value pegged to the price of a fiat currency or some other physical store of value. Why, if this wheel that is fiat-pegged digital currency has already been invented, do we need to reinvent it?
Avivah Litan, distinguished analyst and VP at Gartner specializing in AI and blockchain, said that stablecoins still aren't actual fiat currency, only a representation of such currency on a blockchain. Cash reserves are still required to back stablecoins, too, while CBDCs are actual fiat currency: If the US started issuing a digidollar, that dollar would be practically the same as a paper one.
Another major way that CBDCs differ from cryptocurrencies is their centralization. Put simply, if you love cryptocurrency for its non-hierarchical, libertarian and distributed foundation, you'll hate CBDCs.
CBDCs aren't necessarily on a blockchain either, Litan said.They live on electronic ledgers, of which multiple copies may exist, but there's no actual blockchain technology needed to create, issue and make CBDCs usable, just a central database.
It's not too difficult to think of ways that CBDCs could be misused, or used to nefarious ends. CoinDesk points out that governments could use a centralized ledger to track its citizens and otherwise violate their privacy, while Litan warned that terrorist groups and hostile nations could use CBDCs as a way to avoid sanctions.
As one example, Litan cited China, which is the current global leader in CBDCs, with its digital Yuan already available.
"China is already piloting it and they tested a government-to-government and business-to-business blockchain network for making payments in digital Yuans," Litan said. "If you put these payments on blockchain networks or any closed network, which China can do once their currency is more mature, they can bypass the typical banking system."
CBDCs and cryptocurrencies: Oil and water?
The first thing that came to my mind when I heard of CBDCs was that they were an attempt by fiat currency issuers to tamp down cryptocurrencies and eliminate their influence. Litan confirmed my suspicions, saying that governments, especially more authoritarian ones, hate cryptocurrencies and see CBDCs as an exit ramp.
"[Governments are] definitely threatened by crypto. It's banned in Russia, India, China and all the authoritarian governments hate it," Litan said, because it allows citizens to access a store of value that it can't regulate or control in any way.
Facebook's launch of Libra, its own cryptocurrency, was a major impetus for China's acceleration of its digital Yuan project, now the most fully realized CBDC in the world.
Given China's well-publicized ban on all things crypto and its massive expansion of its own CBDC, it seems like there's bound to be a clash between the two forms of digital currency that's bound to be the death of one or the other, right? Not so, Litan said.
If CBDCs were used by individuals as a regular form of currency, each person would need to have access to a digital wallet, likely in the form of a smartphone app. "Maybe that wallet will also support Bitcoin and Ethereum and everything else, so it starts getting more people into crypto. If there's digital currency everywhere, there are a lot more onramps," she said.
But according to Litan, this isn't likely to happen in any authoritarian state. Those countries, like we've seen with China and Russia, don't like to allow uncontrolled currency within their borders. Less authoritarian regimes, Litan said, would be able to accept cryptocurrencies, especially stablecoins that are pegged to fiat currency.
SEE: IT leader's guide to the blockchain (TechRepublic Premium)
The current state of CBDCs around the world
At a symposium in September, Litan led a panel that included Cleopatra Davis, head of banking for the Central Bank of Bahamas; Mithra Sundbeer, head of E-Krona for Riksbank Sweden; and Jim Cunha, SVP at the Federal Reserve Bank in Boston. Each of them shared information about their particular nation's CBDC initiatives, why it launched the program, and how it has shaped up so far.
The Bahamas, which was the first country to introduce a CBDC with its Sand Dollar, formally launched its program in October 2020 and made Sand Dollars available through authorized financial institutions, of which there are now nine.
Several government agencies have begun accepting Sand Dollars as a settlement method, and they're being used for other purposes on eight of its ~30 inhabited islands. The Bahamas also had great success with using its CBDC system to directly distribute COVID benefits during pandemic lockdowns and describes the Sand Dollar as "a convenient, secure, cost-effective contactless payment method with remote/digital access to financial services."
Over $273,000 in Sand Dollars had been issued as of the end of August 2021, and the country plans to further integrate it into its economy in the coming years.
Sweden's E-Krona is nowhere near as far along as China's Yuan or the Sand Dollar, with Sundbeer describing it as being in the investigatory phase. An initial pilot program happened early in 2021, and February 2022 will see the beginning of a second phase, followed by a parliamentary hearing in November 2022 to review the outcome and develop future plans.
Project Hamilton, the US CBDC project, is further in its infancy, with the Fed still trying to address possible pain points before stepping further into the process.
Hamilton is a collaborative effort between MIT's Digital Currency Initiative and the Boston Fed, and the team plans to release a joint research report into its investigation of CBDCs for use in the United States.
Other nations testing CBDCs are also in stages of early development, but it seems clear that there's a growing desire to, if not implement it now, at least prepare for its inevitability.
Should you prepare for the coming of CBDCs?
Cryptocurrencies are risky, volatile investments that have chased many a CFO away from even looking in their direction. That changed in 2021, though, as Bitcoin skyrocketed and crypto started attracting a ton more attention. Gartner is now saying that digital currency use by enterprises will grow by 20% by 2024, so it's best to take steps to prepare for the coming onslaught.
With that in mind, Gartner makes several recommendations for application leaders worried about the defi/crypto/blockchain future:
Work with organization counterparts in the government, legal and compliance realms to determine what you'll need to support any potential implementation.
When dealing with stores of value, prepare to integrate next-gen currency software with legacy systems and determine now whether you want to outsource currency custody or handle it in-house, because it's going to be a cybersecurity nightmare.
For payments, you'll need to be ready to integrate digital currency payments with the applications that need it, like B2B supply chain software or B2C points of sale where customers may want to use CBDCs.
If using digital currencies for leverage applications, prepare to focus on finding the solution that meets your own internal control and security requirements.
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