Today we can observe changing habits and patterns of how payments are conducted. Although still prevalent, cash is becoming less popular and it is being replaced by different kinds of digital payments. The financial ecosystem is growing rapidly and many digital currency concepts have emerged that make it easier to get away with money. Moreover, as more purchases are made online, the pandemic has naturally helped to increase the use of digital currencies.

A central bank digital currency (CBDC) could completely revamp the global financial system as we know it. Through CBDC’s, fiat money will become truly digitalised and finalise the merger between monetary and fiscal policy.

The development and implementation of digital government money is not necessarily a trend or development one might trade, but rather represents what could be the biggest change to how the financial system is constructed and operates, and is a development everyone must be aware of and would do well to educate them on.

Central Bank Digital Currency

Governments that legally recognize the CBDC in the jurisdiction of the central bank can use them to make payments to anyone and every business must accept them.

In simpler terms, CBDC is short for Central Bank Digital Currency, an electronic form of central bank money that citizens can use to make digital payments and store value. A CBDC offers three main elements:

• A digital currency
• Issued by the central bank
• Universally accessible

Way of exchanging CBDC

Means of exchange

Decision on how CBDC could be obtained will be another factor impacting the whole financial system and banks. There are different considerations which setup should be applied. The least impactful approach would be when only government bonds are directly exchangeable for CBDC. A more liberal approach would enable purchasing CBDC by cash. The most impactful approach would allow direct exchange of banking deposits in fiat currencies into CBDC.

Regulatory requirements

Minimum requirements defined by local regulatory bodies in order to offer services related to CBDC (e.g. a wallet for CBDC storage, payments and exchange) will determine the entry barriers and thus the competition in the CBDC system. While these features are the most important when analyzing the potential impact of the CBDC system on banks, there are also other considerations that should be mentioned. They include the approach to the CBDC implementation itself – whether it will be done gradually or issued as a one batch (“big-bang”). Moreover, there is the question whether CBDC will bear interest rates and if yes, how they are different compared to fiat currency interest rates. Also the level of existing interest rates and the economic situation in general will have considerable importance, because they will trigger general demand for CBDC (considered as a safe form of holding assets) and consequently the total value of assets converted into CBDC.

Difference between CBDC and Cryptocurrency

Whether it can emerge as an instrument of investment will be dependent on its design, ease of availability and fluctuations in value, if any. CBDCs will have to be a public good provided by the central bank. The pandemic has pushed consumers to go increasingly cashless and CBDCs might complement, rather than replace, physical cash in the system. If implemented, a CBDC would be a claim on the central bank issuing it.

A main difference that CBDC would have from cryptocurrencies is that the former would be centralized unlike the latter.

Conclusion

Central Banks have started exploring CDBC issuance as a new form of money. CBDC is expected to serve as digital money to solve the diminishing use of cash in some countries and others are considering CBDC as an innovative method that brings financial stability in the economy. However, CBDC acting as a new payment technology may soon be available in a number of countries around the world and situations like COVID-19 may ignite this process. Central Banks can benefit and learn from each other by sharing best practices, approaches and technologies mutually and thus contribute to the most advanced payment platform in the financial system. Central banks in the UK, Sweden, Euro Area, Canada, China and India are among those who are exploring the feasibility of a CBDC.