A handful of events and trends over the last few years have put the future of finance into sharp focus.
First there was the rise of cryptocurrencies – digital currencies based on a decentralised system of recording and verification called the blockchain.
Then there was Covid, a global pandemic that forced many businesses and consumers to trade traditional cash transactions for digital equivalents. By some estimates this sped up the decline of cash by as much as four or five years.
Finally, and most recently, there was the loss of confidence in private cryptocurrencies. The collapse in late-2022 of trading platform FTX, in which billions of dollars simply went missing, highlighted to many the risks of this scarcely regulated space.
These factors have each played a part in pushing a new technology, central bank digital currencies, to the fore.
What are central bank digital currencies (CBDCs)?
In the simplest terms, a CBDC can be thought of as a digitised, cryptographic version of traditional, government-issued fiat currency.
In terms of the underlying technology, a CBDC can closely resemble a cryptocurrency. But there are a number of ways in which CBDCs are very different to the likes of Bitcoin and Ethereum.
There are two key issues with cryptocurrencies: wild price fluctuations and limited use. CBDCs seek to solve both issues by functioning like digital dollars. The idea is for a CBDC to bring the same security and immutability as a cryptocurrency, while offering the same authority, stability and widespread acceptance as traditional fiat currency transactions like cash and credit card payments.
The overwhelming majority of central banks around the world are exploring digital currencies, and a few, most notably China, have already launched one.
Why are central banks looking at digital currencies?
Why are governments around the world so eager to develop digital dollars, pesos, euros and crowns? Advocates cite a few key and unique benefits that CBDCs, and only CBDCs, can deliver:
A more inclusive economy: Financial exclusion is a huge problem globally. Around 1.4 billion people, predominantly in developing economies, remain ‘unbanked’. Digital currencies lower the barrier to entry, offering an easy way for everyone to conduct small-scale transactions without cash or card.
Simple and efficient: CBDCs cut out the middleman – digital dollars are transferred direct from one digital wallet to another, in the quickest and easiest of processes.
Secure, immutable: Much of the tech used by CBDCs is borrowed from the best bits of cryptocurrencies, such as the security and immutability of the blockchain. (One key difference, however, is that unlike decentralised crypto, CBDCs are by definition centralised.)
When will CBDCs become mainstream?
Central bank digital currencies are already more mainstream than many people might think.
In October 2020 the Bahamas launched the sand dollar, the world’s first CBDC. In April 2021 China became the first major economy to follow suit – its digital renminbi (or e-CNY) began with a limited public release that has since expanded.
Many developed economies are on the precipice of going cashless thanks to their investment in CBDCs – Sweden is the frontrunner, with plans to go fully digital as early as March 2023 with the help of the E-krona.
If successful, these early case studies will lay the foundation for other countries to accelerate the development of their own CBDCs.
Will CBDCs replace cash?
Between credit cards and smartphone payments, cash had been in decline for decades before Covid, but the pandemic may well have sounded the death knell. It highlighted the limits of cash, and spurred many countries, particularly those mentioned above, to develop CBDCs.
But while developed nations march toward a cashless future, the story is a little more complicated in the global south, where millions of unbanked individuals exclusively pay with cash. The process of moving from cash to digital currencies will be a particularly slow one in the developing world, as a number of key milestones need to be reached:
The development and successful introduction of a CBDC.
Educating the population on the whats and whys of said CBDC.
Ensuring every individual has access to the technology required to participate in a CBDC-driven economy.
Each of these steps will demand a monumental effort from governments in the global south and will likely take many decades to achieve. Nevertheless, most experts agree that no matter how many years it may take, the days of cash are numbered.