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The world of finance is shaking up as central banks worldwide speed up exploration and creation of CBDCs (Central Bank Digital Currencies).
The process that started as a somewhat tentative exploration of digital solutions has become an all-out race to update monetary infrastructures among various global nations.
More than 100 countries are currently studying or testing their digital currencies.
CBDC revolution comes into shape
CBDCs are more of an overhaul of what money should be.
Unlike alternative cryptocurrencies like Bitcoin or Ethereum, CBDCs are online equivalents of a national currency, given the equivalent value of the government-issued paper notes.
Still, they have the stability and the support of classical cash paired with the efficiency and creativity of digital currency.
The drive towards CBDC development has never been as high before.
According to the latest figures given by the Bank for International Settlements, among central banks, 93% already work on CBDCs, and many have shifted the focus to actual pilot programs and policy designs.
The current uptake indicates that the world has realized that digital currencies are not just experimental technology but needed infrastructure in the future of finance.
Who is taking the front seat in global CBDCs
China has become the leader in implementing CBDC DCEP (Digital Currency Electronic Payment) or the digital yuan.
China has already conducted billions of dollars of digital yuan transactions through huge pilot programs in large cities such as Shenzhen, Beijing and Shanghai, showing the practical feasibility of retail CBDCs on a large scale.
The European Central Bank has been thorough in its methodology in the digital euro project, involving research and consultations with stakeholders.
Protecting privacy and living in harmony with cash are of primary importance in the design, highlighted by the ECB officials due to the current issue of people being afraid that the central bank could spy on them and become financially excluded.
The United States Federal Reserve has been cautious and has concentrated on research and international cooperation rather than being in a hurry to do anything.
Federal Reserve officials say they are less concerned with being the first country to distribute CBDC and more interested in getting its design correct, with the global consequences of the digital dollar.
The Bank of England is still exploring that idea further through extensive research papers and consultation with the public.
The Bank of Japan has already conducted proof-of-concept experiments with lower-level CBDC functions and system stability tests.
Technical architecture and design of consideration
Technical and policy decisions relating to the CBDC development are pretty complex and will determine the future of digital money.
Central banks must balance against set priorities privacy and transparency, innovation and stability and financial inclusion and security.
A decision on wholesale versus retail CBDCs is a basic design choice.
The wholesale CBDC is aimed at interbank payments and high-dollar transactions, giving the possibility of transforming settlement systems and cross-border payments.
The availability of retail CBDCs to consumers and businesses can change how people conduct everyday transactions and the transmission of monetary policy.
Privacy protection is a critical aspect of the design of CBDC.
Though central banks have understood that privacy is essential, they have also taken note of the regulatory need in combating AML (anti-money laundering) and terrorist financing.
Such a delicate balance between finding the right balance needs advanced technical solutions, such as ZKPs (zero-knowledge proofs) and techniques of differential privacy.
Functionality when not online is another major factor, which would ensure that the digital currencies can be used even when not connected to the network or when there is low connectivity.
This would be necessary to facilitate the universal accessibility of physical cash.
Policy and economic implication
CBDCs have severe implications for the effectiveness of the monetary policy and financial stability.
There is a chance that central banks might gain greater insight into the flow of money and the economy and be in a better position to react to economic shocks and targeted intervention.
Commercial banks’ disintermediation is a significant issue in CBDC design.
If consumers directly own digital currency with the central banks, the traditional banks may lose deposits and have difficulties in their lending operations.
Some possible methods the central banks are considering to counter this risk are interest rates and holding curbs.
The DCC implementation may revolutionize cross-border payment.
Transactions across borders, which nowadays require days to complete and come with exorbitant costs, might be made instant and cost-effective.
This will, however, need the coordination of central banks and solving intricate regulatory and technical interoperability issues.
Financial inclusion is one of the most significant potential uses of enhancing CBDC.
Digital currencies would offer banking services to the unbanked, allowing them to send remittances at a lower cost and allowing a more efficient provision of government payments and social assistance.
Difficulties and risks
Although it is possible to note the potential benefits of CBDCs, central banks have to consider many essential issues.
Cybersecurity may be the biggest threat since digital currencies may become the focus of sophisticated attacks.
Central banks have to adopt a high level of security without compromising performance and experience.
The public stakeholders have been focused on privacy issues. The citizens are concerned about government spying and the possibility of surveillance of transactions.
Central banks must balance what people are rightfully entitled to in providing privacy and what they require in compliance with regulation and law enforcement.
There are also permanent difficulties of technical complexity CBDCs must be linked with current payment systems, regulatory regimes and international norms.
Designing systems that can be up and running 24/7 and resilient thrusts on complexity even further.
Relationships with the existing system of payments must be considered well when CBDCs coexist.
Central banks need to be sure that digital currencies should co-exist with cash and private means of payment, not substitute them, and thus preserve choice and competition in the payment environment.
The road ahead is to emerge.
Since the pace of creating CBDC is growing worldwide, some main trends are starting to appear.
As the number of countries launching their CBDC grows, so will the need to have interoperability between various systems of different CBDCs.
International bodies strive to develop harmonized parameters and procedures to enable cross-border transactions of CBDC.
Public-private partnerships are becoming necessary for the successful implementation of CBDC.
Central banks are partnering with technology providers, financial establishments and payment providers to exploit already established expertise and infrastructure and remain regulatory supervisors.
Launch plans of CBDC differ significantly across jurisdictions and continue to evolve as priorities, technical capacity and regulatory frameworks differ.
Although certain countries might issue retail CBDCs by the end of the current decade, others will engage in less ambitious plans, which may also take the position to the end.
Consequences of cryptocurrency system
The entire cryptocurrency world has some significant implications for the development of CBDC.
Although the demand that CBDCs and cryptocurrencies address, and the markets where they operate, resemble each other, their co-existence will probably transform the digital asset market.
CBDCs can popularize the idea of digital funds and speed up the transition to digital payment, which can cause beneficial spillover into cryptocurrency consumption.
The interoperability of both, however, is not transparent in most jurisdictions.
CBDCs’ programmability properties have the potential to add components of DeFi (decentralized finance), which would allow smart contracts and automated transactions in the classic monetary environment.
Such would confuse the boundary between conventional finance and cryptocurrency innovation.
Conclusion
On a worldwide scale, exploring the possibility of using central bank digital currencies is a breakthrough in monetary history.
Since central banks are transitioning to implementation and not research, today’s choices will define future generations’ financial fabric.
Technical, economic and social factors are complicated and require serious negotiations.
The central banks must coordinate innovation and stability, efficiency and privacy, nationalistic interest and international collaboration.
The risk is significant inadequate design or launching of CBDCs might destroy the public confidence in digital money and INGRESS redraw the process of financial innovation.
The following period of CBDC development will play a critical role in defining whether crypto can make good on its potential to become more efficient, inclusive and resilient money.
With pilot programs in full swing and the horse being put at the launch starting gates, the world awaits to be surprised as to whether CBDCs will bring about a whole new era of digital finance or endure the pressures that have traditionally undermined monetary innovations.
The CBDC revolution cannot be summed up in terms of technologies it is the redefinition of the infrastructure that modern economies rely on in the digital world.
To succeed, it will be necessary to achieve levels of collaboration between central banks, governments, technology providers and consumers never-before-seen to design digital currencies that satisfy the interests of all parties to the system without undermining the stability and trust that are the hallmarks of the modern monetary system.
Erick Otieno Odhiambo is a full-stack developer freelancing for crypto-based projects and blogs, with a strong interest in blockchain technology. He has years of experience in software development and creating content. His goal is to teach and encourage with well-researched stories about Web 3.0.
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