Decoding CBDCs: Advantages & Challenges in the Digital Monetary Landscape

Industry InsightsJanuary 17, 2024

What does the acronym CBDC stand for, and why is it becoming the talk of the town? This article explores some of the benefits and downsides — especially when it comes to privacy — of this digital monetary alternative.

Central Bank Digital Currencies (CBDCs) are digital forms of a country’s national currency that are issued and regulated by the central bank. These digital representations of a country’s existing currency (like the US dollar or the Euro) are intended to be a digital alternative to physical cash.

As of June 2023, 11 countries have developed and adopted their own digital currency. The Bahamian Sand Dollar was one of the first projects to be deployed (in 2019), and one of the latest is the JAM-DEX, from Jamaica. China has also launched a pilot project for its own CBDC in some of its cities with a model where the money is issued by the People’s Bank of China but is managed by private national banks. According to this McKinsey & Company article, the idea is to span its use to the whole country and enable transactions and payments through widely used platforms like WeChat. If you want to know more about the e-CNY, check this article.

Statista states that the European Union, Canada, and other countries are also working on the creation of a central bank digital currency, and they’ve kickoff the planning stage this October, after a two-year-long research phase that included understanding the citizens’ response to such an implementation, as well as what tools were needed to do so. According to an article from the European Central Bank, the idea is to implement a “digital euro that would be widely accessible to citizens and businesses through distribution by supervised intermediaries, such as banks.” There are even studies for cross-country digital currencies — the mBridge project includes the banks of China, Thailand, Hong Kong, and the United Arab Emirates.

These central bank currencies have numerous benefits and are designed to ease transactions and take away the middlemen, which in most cases means private banks. Let’s explore some of the benefits of CBDCs implementation and use:

Regulation — Its issuing, management, and use are regulated by central banks, which also makes it easier to ok them from a legal standpoint.

Efficiency of payments and financial inclusion — Although these digital currencies are issued by a central bank, users don’t need to have a bank account. All they need is a cell phone and a digital wallet, with which they can then make payments of different sorts. Digital currencies foster financial inclusion because they allow people without access to traditional banking services to use other methods besides notes and coins. It also enables faster and cheaper transactions.

Tackling illegal economic activities — Although crypto has paved the way when it comes to cash independence, it also become an avenue for illegal activities. The fact that CBDCs are handled by central banks helps ensure the legality of related transactions.

Coin stability — CBDCs are supposed to be much more stable than any crypto coin because they rely on the stability of the central banks themselves and are managed according to official rates and changes.

Privacy and Centralization Issues

However, there are also downsides to the implementation of CBDCs, mostly related to privacy and centralization, but also cybercrime. Digital transactions can be tracked and monitored more easily than cash-based ones. Striking the right balance between privacy and regulatory needs is a challenge that policymakers must address. The crypto community has raised concerns about the fact that the issuance and management of CBDCs is controlled by a central authority, thereby undermining decentralization, one of the core principles of crypto. Like crypto, most central bank digital currencies are blockchain-based, but the big difference between both is that the first is decentralized and unregulated, and the latter is regulated and issued by a renowned entity, and its value is tied to its respective fiat.

Last month, the blockchain-based digital payment network, Ripple, published an extensive research paper that explores the benefits and obstacles of implementing digital money issued by central banks. Financial inclusion — of people who have no access to the banking system — monetary regulation, and sustainability are just some of the paper’s highlights. Ripple also raises some concerns regarding the widespread establishment of this model. They include a lack of an international regulatory system of access to physical cash, and the struggle to confirm digital identities. The latter is, in a way, something that Integritee can help with. Decentralized identities are becoming increasingly popular within the crypto space, and also for KYC purposes. If you want to know more about its potential, check our article on the subject. Ripple has been working with several central banks around the globe to help implement these CBDCs in a way that benefits both sides.

The adoption of CBDCs introduces new challenges related to cybersecurity and operational risks. Ensuring the security of digital transactions and protecting against potential cyber threats is a critical aspect of implementing CBDCs.

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