It feels as though it was just yesterday when Bitcoin entered the playing field. For a quick reality check, that was almost twelve years ago. It has been almost 11 years since Laszlo Hanyecz bought two Papa John’s pizzas for 10,000 bitcoins. Regardless of how mundane the purchase of pizzas may seem, the event is so much more than that; it is considered one of the first transactions using a cryptocurrency. And since then, the currency has definitely seen its fair share of obstacles. A majority of the public continues to be anxious about measuring money that could never be in their back pocket. However, now, people are beginning to recognize the potential of digital currencies. What sparked the change? Central banking digital currencies (CBDCs).
In simple terms, digital currencies are a form of monetary assets that are stored and exchanged through digital means. Currencies like Bitcoin and Diem (formerly known as Libra) are considered decentralized cryptocurrencies as they are not regulated by any authority. On the other hand, a CBDC is a different type of digital currency compared to those like Bitcoin. These digital currencies can be thought of as the virtual version of a particular nation’s currency. Unlike traditional financial institutions, CBDCs remove the third party and allow us to have direct access to central banks.
But, CBDCs aren’t necessarily as complicated as we think. The concept is actually quite similar to other digital paying platforms; we – as consumers – can use our phones to exchange money with both digital and physical stores. Such services have developed around the world, providing a fast and simple way to transfer money. The Kenyan service M-PESA – founded by Safaricom in 2007 – was one of the first players to facilitate ease of payments in the African market. It has now helped over 41 million customers have low-cost digital transactions in seven African countries. Following suit, many emerging countries saw this as a low-cost and efficient way to transfer funds. Over in the United States, PayPal has become a staple for most customers and businesses. This growing dependence on digital wallets, which is a core part of how digital or cryptocurrency changes hands, has accelerated the adoption of digital currencies, encouraging nations to recognize the technology’s value.
Today, one of the leading nations in the development of CBDC is China. In February 2021, Beijing distributed 50,000 digital red packets that contained 200 digital yuans for use in both physical and e-stores. Many analysts see the announcement as a way to prepare for the Olympic season during the Beijing winter games of 2022. However, several other factors are sparking the transition.
Governments and consumers recognize the reducing need for physical currencies, encouraging investigations into technology like Bitcoin.
The Chinese government fears that physical money is easier to counterfeit while simultaneously being more expensive to produce and store. Additionally, though the government promises to leave transactions anonymous to a certain extent, the government hopes to gain more access to analyze and catch illegal activity. With these benefits, the government will also be able to accelerate the internationalization of the yuan. As of 2020, the yuan only accounted for about 2% of the global foreign exchange reserves. Though the US dollar’s share in the global currency reserves is decreasing, it accounted for around 60.4%. For decades, China has been attempting to compete with the United States to hold a currency for global exchanges, and their CBDC may just help close the gap.
Most governments – including China – can agree on a few critical benefits tied with CBDCs. Countries are experiencing heightened anxiety from the competition and changes threatened by cryptocurrencies such as Bitcoin and Diem. And, for several western countries, there has been a decline in cash usage as many shifts towards debit cards. The first one in the race? The Bahamas and Eastern Caribbean.
Unlike what most would expect, the smaller Caribbean countries have been leaders in change for digital currencies, being the first to produce a digital currency equivalent to cash. The Sand Dollar – from the Bahamas – and DCash – from the Eastern Caribbean Currency Union – were the first CBDCs to be released for the masses. Both parties emphasize the importance of increasing the affordability of e-payments. Especially in the context of the Covid-19 pandemic, poor communities require faster and easier ways to deposit money. CBDC allows these families to leave other financial institutions – such as banks – in order to have direct access to their money. The Eastern Caribbean Central Bank is especially optimistic about the transition, hoping to reduce cash use by 50% by 2025.
Europe continues to be slow to hop onto the bandwagon. Just recently, Sweden has entered their testing phase. While working with Handelsbanken to test their e-krona, the nation hopes to include commercial banks in their future test to understand the consequences on large and small payments. The United Kingdom continues to be wary of the potential changes with the introduction of digital currencies. Since 2006, the UK has seen a consistent decline in cash payments with increased debit card payments. In fact, in 2017, the percentage of total payments that used debit cards finally surpassed cash, suggesting a significant cultural shift away from the physical currency. On April 19, 2021, The Bank of England and HM Treasury announced the creation of the Central Bank Digital Currency Taskforce to investigate a potential UK CBDC. Also in April, the Bank of Japan began an experiment into launching its own digital currency. Japan hopes to better understand what the CBDC would look like and move to its second phase by the end of 2022, which will determine the entities serving as intermediaries between the Bank of Japan and deposit holders. A CBDC could completely transform Japan’s financial industry.
Even as the world is shifting towards better understanding CBDCs, Wall Street continues to be cautious. Many investors predict that larger banking institutions may lose out as much of their business moves to the cheaper alternative of CBDC. And with that transition to digital currency, Americans fear that the central bank will gain too much influence as loans become increasingly dependent on the will of the Federal Reserve. Beyond the internal issues, Americans are anxious that China’s progress with the digital yuan may, in fact, undermine the USD.
But, what does this mean? Firstly, cash is not going anywhere. Governments have made it clear that their digital currencies will just be another way to support their citizens rather than to remove a significant payment method. However, it is important to note how our dependence on cash is being tested. Governments and consumers recognize the reducing need for physical currencies, encouraging investigations into technology like Bitcoin.
It is time to adapt to a new way of buying our favorite commodities. Many analysts claim that there will be unintended consequences, many of which are extremely difficult to predict. For now, more nations and citizens may just need to investigate how CBDCs are truly going to shake our world.