The world’s financial ecosystem has experienced transformations over the last decade.
Financial tech firms and crypto exchanges — some barely four years old — threaten to shift loans, deposits, and payments out of banks and into their uncontrolled networks.
In short, digital currencies are undermining and threatening the central bank’s mandate and financial sector’s stability — even creating a wild west for global finance.
Now, a central bank of digital currencies (CBDC) is poised to emerge to help retain control over future financial transactions.
China is already seven years into researching and designing a CBDC network. The European Central Bank plans to introduce one in 2025. But the Federal Reserve and Bank of England are taking baby steps.
How will CBDC Transform Financial Systems?
CBDC will be a cheaper and more inclusive financial system. It will allow individuals and businesses to hold accounts directly linked with the central bank — providing efficiency during transactions.
However, CBDC implementation will end the role of banks as financial intermediaries.
The entire core of bank business models will dwindle as few deposits and loans will be made. Banks will no longer collect fees as usual, thus ending their growth.
But how will the central bank step in to fill the lending gap left by banks? A new system is more probable; it will be created to assist customers keep CBDC accounts at a bank or other third-party provider.
Will CBDC Pose Challenges?
Because CBDC has the central bank’s backing, it’s a safer financial system. But in a crisis, customers can switch out of the CBDC system when they run out of cash, then rush to banks.
Even if CBDC offers low-interest rates than commercial banks, nothing will guarantee their flight to safety. If CBDC limits cash withdrawals, that will simply make customers buy unregulated cryptos.
CBDC could work well — even boost inclusion — if they allow people to have bank accounts. Because not everyone has internet access to transact online.
Then again, how will CBDC guarantee its customers’ privacy? Will the system track all the customers’ spending details? 23% of Americans don’t trust banks. They want privacy.
So CBDC should factor these concerns by creating a token-based system to help customers transact anonymously.
Designing a well-working CBDC system is crucial. Why? Because a lot needs to be considered, including cross-border payments, good governance, and bilateral arrangements — even anti-money laundering efforts.
The government assuming that “if it’s digital, people will board” is too simple an idea. They should just go slow on digital currencies.
