With decentralized cryptocurrencies like bitcoin so widely used, many countries are considering government-sponsored digital currencies, also called digital fiat currencies or central bank digital currencies (CBDC).
China has effectively leapfrogged the West by conducting a limited trial launch of its digital yuan. However, other countries may not be far behind—according to the Economist in 2020, some 80% of central banks were studying CBDCs, including the U.S. Federal Reserve.
It’s clear that CBDCs have the potential to revolutionize monetary systems. What are the issues prompting the move toward CBDCs, and what does China’s e-yuan mean for the rest of the world?
How do central bank digital currencies differ from other cryptocurrencies, and from digital payment technologies?
Most people have used digital payment technologies like Venmo, Apple Pay, and electronic bank transfers to complete transactions. However, these are technologies that move money around, not a different form of currency.
CBDCs also differ from decentralized cryptocurrencies like bitcoin and Ethereum. These cryptocurrencies are not considered legal tender (recognized by law as a means to settle public or private debts, like the U.S. dollar). At the same time, most countries do not forbid people from using cryptocurrencies. Because they are decentralized, these cryptocurrencies are by definition not regulated by one authority; if both parties in a transaction agree to use bitcoin, they can. For tax purposes in many countries, a cryptocurrency may be considered property, rather than currency.
In contrast, a CBDC is legal tender, issued and regulated by a country’s central banking authority like the dollar in the U.S. It is a virtual form of government-issued currency and would be backed by reserves. Because CBDCs are still in the research, development, or pilot phases in several countries around the world, there are still many uncertainties regarding exactly how they would work from country to country.
Why are national governments interested in CBDCs?
Just a few years from now, global digital transactions are predicted to top $9 trillion. Some experts contend that countries around the world need to develop their own cryptocurrencies just to catch up with this trend. Others say that the popularity of cryptos may pose a threat to a central banking authority’s ability to regulate monetary policy.
CBDCs take the convenience of cryptocurrencies and marry it with the regulations and government control of the traditional banking system. It is increasingly expensive to manage and transfer physical cash, and CBDCs could reduce this cost while allowing greater insight into the flow of money within an economy. A state-sponsored digital currency might also promote financial inclusion, enabling individuals without a bank account to access the financial system.
At the same time, critics contend that transactions made with CBDCs would not be anonymous, since by definition CBDCs are a centralized form of cryptocurrency.
Which countries are exploring CBDCs?
In February, the Atlantic Council published this helpful map showing the state of CBDCs around the world. Many countries, including the U.S., are in the research phase. Brazil launched Pix, an instant money transfer system, last year but has not launched a true digital real. Sweden, Thailand, and Ukraine are in the pilot stage, along with China.
Ecuador presents an interesting case and possible cautionary tale, though the circumstances behind its CBDC are unique. Ecuador adopted the U.S. dollar in 2000, then 15 years later became the first country to implement a state-run electronic payment system. The dinero electrónico (DE), as it was called, was intended to support the country’s dollar-based monetary system, not replace it. However, the DE was widely mistrusted, with relatively few citizens using it. It was abolished in December 2017.
How is China leading the way with its digital yuan?
China’s digital yuan has been in development for more than five years, and the country is the first major economy to issue a CBDC. Real world trials of the digital yuan are currently underway in several regions and cities, including Shenzen, Suzhou, Chengdu, Xi’an, and Shanghai. South China Morning Post reported that more than 100 million yuan have been allocated by lottery to tens of thousands of people. The currency can be used for shopping in certain participating stores, paying utility bills and government services, and paying for catering services.
The digital yuan is tipped to increase competition in China’s mobile payments market, an arena currently dominated by Tencent’s WeChat Pay and Ant Group’s Alipay.
Supporters of decentralized cryptocurrencies have criticized the digital yuan’s lack of anonymity. Representatives of the People’s Bank of China have contended that the digital yuan will have “controllable anonymity,” meaning that users will not be able to view other users’ identifying information unless they provide it. However, the bank itself will still be able to monitor the entire user base.
How does the digital yuan affect the U.S.?
Some economists have voiced concerns that the yuan is becoming an increasingly strong challenger to the U.S. dollar, threatening the dollar’s status as the mainstay of international commerce.
In an interview with CNBC, however, Fundstrat head of digital assets research David Grider voiced skepticism about the impact of the digital yuan. He explained that he did not believe that the digital yuan would materially change very much in terms of the dollar’s role in the world, because of the fundamental differences between the two countries’ monetary systems.
Nevertheless, other analysts caution against complacency, warning that the U.S. runs the risk of falling behind globally if it doesn’t prioritize the development of a CBDC.
What is the U.S. Federal Reserve doing with regards to a CBDC?
In the U.S., the concept of a digital dollar has so far garnered a lukewarm reception. In September 2020, the Federal Reserve Bank of Boston announced that it was working with MIT on a multi-year research initiative that will test hypothetical CBDC systems for wide-scale use, with a focus on architecting a scalable, accessible cryptographic platform.
In March, Federal Reserve chair Jerome Powell described the Fed’s research into CBDCs as “early and exploratory,” according to the New York Times. He said the U.S. would only consider a CBDC launch if there was widespread buy-in from the public and political leaders. He cited money laundering and cybersecurity vulnerabilities as risks tied to CBDCs that could disrupt the country’s banking system.