The financial landscape is on the cusp of a significant transformation. Central bank digital currencies (CBDCs) are rapidly emerging as a potential game-changer, promising to reshape how we interact with money. These digital tokens, issued by central banks and pegged to the value of a nation’s fiat currency, hold the potential to revolutionize how we conduct transactions, manage financial systems, and even create entirely new markets. Instead of being backed by a physical commodity, such as gold or silver, they are state-issued with its value fluctuating with market demand and supply, as well as the stability of the issuing government. Naturally, these currencies are designed in a way that is in line with the objectives of their respective central banks, allowing them to be more efficient and effective in their policy implementation. So, what are the potential benefits and opportunities associated with CBDC? What are the challenges that may come in the way?
The rise of digital transactions has provided banks with a privileged position, granting them access to a vast pool of customer data that reveals spending and saving habits. This information is crucial for central banks, as it allows them to refine economic forecasts and tailor the implementation and execution of monetary policies. For instance, by analyzing household spending behavior, policymakers can assess the effectiveness of raising real income levels on private spending, ultimately informing trade-offs between various policy options.
Moreover, with the rapid boom of cryptocurrencies and blockchain technology, central banks are gradually losing their grasp over the future of money. As of August 2023, Bitcoin alone accounted for a stunning $1.35 trillion market capitalization, followed by other decentralized currencies such as Ether (ETH) Tether (USDT) and Binance Coin (BNB), with a market capitalization of $399.1B, $106.7B and $85.5B respectively. This digital revolution, transforming currencies and finance, has understandably caused anxiety among central banks worldwide.
This is evidenced by the launch of Meta’s (then Facebook) stablecoin, Libra (now Diem), in 2019, which was instantly met with both domestic resistance from Members of Congress and regulators, as well as international policy makers, among them, the French and German Finance ministers at the time. Despite the failure of the high-profile cryptocurrency project in 2021, which was largely due to the sustained political pressures in Washington, the surge of decentralized digital currencies appears unstoppable. In this climate of pressure and intensity, the design of CBDCs presents itself as a strategic entry point for state-backed institutions. CBDCs offer a means to re-enter a market currently dominated by private companies, allowing central banks to regain control and establish governance and oversight.
Over the past decade, central banks around the world have gained momentum around CBDC, carefully testing the waters. Australia has adopted a cautious stance, with RBA deputy governor Michele Bullock confirming this standpoint: “I think we just need to keep our toes in it, and not be at the bleeding forefront.” In late 2021, a review of the viability of a retail CBDC issued by the Reserve Bank was formally adopted, with a year-long research project with the Digital Finance Cooperative Research Centre to study “use cases” for a CBDC being announced in August 2022. Similarly, the US Federal Reserve is engaged in a number of experiments related to digital currencies, including a hypothetical CBDC to explore the technology’s opportunities and limitations, with the earliest Federal Reserve research dating back to 2016. Likewise, in October 2023, the European Central Bank (ECB) concluded its two-year investigation phase in collaboration with national central banks across the Euro zone to study the design, distribution and market impacts of CBDCs. Following this, the ECB has officially launched the next phase of the digital euro project – the preparation phase – which involves finalising the digital euro rulebook and selecting providers that could develop a digital euro platform and infrastructure. Moving to the UK, further progress has been made, with the design phase set to commence over the next 2-3 years, where the technology and policy requirements of the digital pound will be carefully examined. According to the Bank of England, UK’s CBDC is projected to be issued as early as the end of this decade, but only under the conditions that the case has been made at the conclusion of the design phase.
Things look different for China, the pioneer in digital currency development, who is doubling down on the so-called digital Yuan, or e RMB. In April 2020, China became the first of the major economies to test a CBDC, rolling it out in only four cities: Shenzhen, Suzhou, Xiongan and Chengdu. However, the trial program quickly expanded, increasing the total number of pilot areas to fifteen provinces and twenty-three cities. Early 2022, the People’s Bank of China reported a total of 261 million people with a digital yuan wallet, a majority of which were created in the hope of winning free cash.
Central bank digital currencies (CBDCs) are generating significant buzz in the financial world. Proponents tout their potential to revolutionize payments by facilitating instantaneous settlements, programmable transactions, and the creation of entirely new markets for tokenized assets. RBA’s pilot projects include the collaboration between CBA and ANZ on the creation of digital representations of biodiversity and carbon credits, where the integration of payment with digital assets provides investors with transparency on the quality of credits.
However, alongside these promising opportunities, uncertainties around regulation pose significant challenges. Questions remain about who shoulders the blame when smart contracts malfunction or anti-money laundering measures are breached. This shift in transaction settlement, highlighted by pilot projects, raises concerns about the potential for power to move from established banks to technology companies or even decentralized networks. Furthermore, concerns exist regarding interoperability – if different standards emerge, fragmentation across the financial landscape could become a major hurdle.
Looking ahead, interoperability between markets and traditional infrastructure appears key to unlocking the full potential of CBDCs. This would prevent the creation of isolated silos for different asset classes. The RBA acknowledges the existence of bank-issued stablecoins and tokenized deposits, recognizing the need to understand how these digital forms of money will interact and potentially complement one another. These elements, including legal frameworks, technological infrastructure, and the risk landscape within the financial system, all require careful consideration before full-scale CBDC implementation.
Tony Richards, chair of the CBDC steering committee at the DFCRC and former head of payments at the RBA, emphasizes the importance of a nuanced approach – exploring all options, including CBDCs, tokenized deposits, and stablecoins, before making a definitive decision. Furthermore, he advocates for international collaboration, suggesting that Australia can learn from the experiences of other jurisdictions while simultaneously contributing its own insights. Ultimately, CBDCs’ success rests not only on technological innovation but also on comprehensive legal reforms and the establishment of global standards. Only through a collaborative effort can the financial world harness the power of CBDCs while effectively mitigating the associated risks.
The CAINZ Digest is published by CAINZ, a student society affiliated with the Faculty of Business at the University of Melbourne. Opinions published are not necessarily those of the publishers, printers or editors. CAINZ and the University of Melbourne do not accept any responsibility for the accuracy of information contained in the publication.
