Countries worldwide, including Nigeria and Jamaica, have embraced central bank digital currencies (CBDCs) as a growing trend. The Bahamas made history by launching the first national CBDC, the Sand Dollar, in 2020. China is also set to join the CBDC movement with its own digital currency launch in 2023. This global interest in CBDCs is evident among G20 countries like Japan, India, Russia, and South Korea, which are actively exploring this innovative form of digital currency.
CBDCs, in contrast to existing cryptocurrencies, offer a centralized approach rather than embracing decentralization like Bitcoin. Cryptocurrencies provide transparency, security, financial inclusion, autonomy, and global accessibility, but face challenges such as price volatility, limited regulation, acceptance barriers, technical complexity, and energy consumption. Centralized currencies, like fiat currencies, offer stability, regulatory frameworks, price management, acceptance, and integration with government systems, but come with drawbacks like lack of privacy, dependency on intermediaries, limited accessibility, vulnerability to political influence, and the risk of central points of failure. Evaluating these pros and cons is essential within the context of specific currencies and their operational environments.
Once Fed has weighed their options on the architecture and tech to use for CBDC, a key decision they’d have to make during their CBDC development process is on how they intend to release it for public use. Unlike existing fiat currencies can be categorized into retail CBDCs and wholesale CBDCs. Retail CBDCs target the general public, promoting financial inclusion and facilitating peer-to-peer payments. Users can store retail CBDCs in digital wallets, ensuring privacy, security, and convenience for digital transactions. Wholesale CBDCs, on the other hand, serve financial institutions as settlement assets for interbank transactions. They enhance financial market infrastructure, improve interbank settlement processes, and aid in liquidity management and regulatory compliance. Retail and wholesale CBDCs differ in intended users and functionalities, although there may be variations and overlaps depending on each central bank’s implementation approach.
Depending on how the use case of a Fed CBDC would go it introduces potential for significant shifts in deposit behavior and liquidity dynamics within the banking system. Especially given the current banking climate where Silicon Valley Bank and Signature Bank failed due to failing to match the liquidity requirements of their short-term obligations. The current banking system’s liquidity management styles would have to evolve as individuals and businesses may opt to hold their funds directly with the central bank, leading to a potential decrease in deposits held by traditional banks. This shift could impact the liquidity base of banks and disrupt their traditional role as intermediaries for deposit-taking. Additionally, the introduction of CBDCs may disrupt the interbank lending landscape, as banks could rely more directly on the central bank for liquidity, altering established dynamics and requiring further adjustments to liquidity management strategies. Now there are other ways this could impact the banking system such as the demand for physical fiat currencies and the like but the volatile environment in which banks exist today makes the liquidity question more urgent, and if the implementation of CBDCs would give Fed the technological and regulation tool upgrades it so direly needs.