What is the central bank digital currency CBDC? Should the central bank develop its own digital currency? Central bank digital currency (CBDC) can improve the payment system, promote inclusive finance, prevent financial fraud and accelerate the transition to a cashless society. However, there are potential shortcomings in consumer privacy and network security threats. Let's learn what CBDCs are, why the government wants to create them, how advanced they are, and the risks associated with these new currencies.

What is the central bank digital currency CBDC?

CBDC is a form of electronic currency issued by the regulated government. Although most cryptocurrencies (such as Bitcoin) are decentralized assets and pure "point-to-point" versions of electronic currencies (Quinn, 2021), CBDC will be supervised by the Bank of England, the European Central Bank, the Federal Reserve and other central banks.

CBDC is being developed to replace the national currency and move to a cashless society. In fact, according to a recent survey by the Bank for International Settlements (BIS), 86% of central banks are actively studying CBDC, 60% are experimenting with CBDC, and 14% are deploying pilot projects.

The Bahamas became the first country to introduce CBDC using the "sand dollar" in October 2020, while Nigeria became the first African country to introduce the digital currency eNaria in October 2021. In China, digital Renminbi (e-CNY) is being developed for cross-border use, while in the United States, two CBDC projects are under way. In September 2021, Federal Reserve Chairman Jerome Powell said that the central bank "is actively evaluating whether to issue CBDC... I think it is more important to do this correctly than quickly".

Why did the government try to create CBDC?

The government has introduced CBDC for many reasons. Here we discuss some of the most important motivations.

First, cryptocurrencies and "stable currencies" like Tether pose a threat. Almost every central bank has prepared a white paper on cryptocurrencies. Although due to practical reasons, many cryptocurrencies can never replace national currencies - such as high transaction costs, scalability problems in transaction and huge volatility (see Quinn, the wonderful discussion in 2021) - the central bank is worried that they are falling behind in this digital revolution and hope to keep pace with the times. The growing interest in and use of cryptocurrencies pose challenges to local currencies, and the issuance of CBDC will help offset this growth.

Secondly, CBDC should improve the efficiency and security of retail and large amount payment systems. In retail, the focus is on how digital currencies can improve payment efficiency, for example, by accelerating point of sale, online and peer-to-peer transactions. Having a CBDC for wholesale and interbank payments may also be beneficial, as it can facilitate faster settlement and longer settlement times, for example. In addition, CBDC can improve cross-border payment efficiency. They may improve the counterparty credit risk of cross-border inter-bank payment and settlement by providing 24-hour availability, anonymity and eliminating the counterparty credit risk of participants.

Third, the introduction of CBDC will accelerate the transition to a cashless society. Due to the convenience of using cards, applications and contactless payment, the use of cash is declining sharply. It takes money to make cash - for example, 14 cents to print a $100 bill - so a cashless society can reduce the cost of the central bank. Cash is also difficult to track, which makes it attractive for tax evasion, money laundering and illegal transactions. Since there is no transaction record, there will be greater security risk when transferring funds and payments. Future governments may want to eliminate cash to reduce crime and increase tax revenues.

Fourth, CBDC can improve financial inclusion. There are more than 1.7 billion adults (4% of the UK population) in the world who "have no bank account", which means that a person "cannot access the services of banks or similar financial institutions". CBDC can enable these people without bank accounts to obtain safe places for saving and eventually obtain credit, thus promoting financial inclusion.

What are the risks of CBDC?

One concern about CBDCs is that they need to centralize the banking industry, which will magnify the threat of cyber attacks. Just as the failure of any bank will weaken people's confidence in the banking industry, CBDC may transfer this risk to the central bank. This will offset the benefits of the strategic risk sharing structure and the distance between financial system participants.

That is to say, the blockchain technology is very secure and transactions are highly separated, which means that the central bank may run a distributed system to more widely disperse the risks and consequences of any possible network security vulnerabilities.

CBDC may also represent a potential violation of consumer privacy and protection. With CBDC, the central bank can easily prevent individuals or groups that are not favored by the government from using funds. The use of money (equal access to public goods is a human right), as well as the preservation, sending, spending and security of money, should be as free as possible, while punishing bad actors to the maximum extent. Tom Emmer, a US congressman, wrote: "The central bank has strengthened its control over currency issuance and has a deep understanding of how people spend money, but it has deprived users of privacy." He added, "CBDC can only be beneficial if it is open, without permission and private."

There is concern that financial inclusion will decline further during the pandemic, as efforts to digitize currencies have intensified. With the introduction of CBDC, this situation may be exacerbated, as they may extend beyond those who use old devices or cannot access digital wallets. Care needs to be taken to avoid further disenfranchisement of older persons, the poor and vulnerable groups.

In general, given the huge transformation to online banking and the speed of digitalization, the central bank will inevitably issue CBDC in the future. The design of these CBDCs may vary from country to country, but in all cases the central bank will remain responsible for the currency.

There is no doubt that they will subvert the banking industry, enable more people to access banking services, provide faster services, and provide credit to enterprises on more favorable terms, while maintaining the liquidity and efficiency of the capital market. Although some degree of privacy will be lost, the benefits of preventing fraud and other crimes may far outweigh compensation.