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CBDC: Over 114 central banks are currently exploring Central Bank Digital Currencies, an improvement from May 2020.
The increased number of banks represents 58% of countries, generating 95% of global GDP.
A team of Bank of America cryptocurrency analysts is bullish about the prospect.
“Digital currencies appear inevitable,” said a research report.
“We view distributed ledgers and digital currencies, such as CBDCs and stablecoins, as a natural evolution of today’s monetary and payment systems.”
The report also covers CBDC’s pros and cons in their issuance and non-issuance and potential approaches to their distribution.
There are also case studies on CBDC development and challenges in specific economic blocs and nations.
Analysts made critical observations about the current financial system’s infrastructure and inefficiencies, which properly developed CBDCs could quickly solve.
Benefits
Once the tech goes live, its potential can remove intermediaries and make them redundant.
As a result, it could bring out the following:
- Complete transparency
- Lower costs
- Real-time settlement
Analysts highlight an estimated $4 trillion of capital banks are required to deposit in corresponding banks that can remove settlement risk.
According to the study, an inefficient capital allocation could generate yield in other places.
The research report also argues that less capitalized banks and payment service providers cannot expand to cross-border payments due to requirements to pre-fund accounts at correspondent banks.
“In reality, cross-border payments are routed through 2.6 different correspondent banks on average, increasing time to settlement,” said the report.
“However, 20% of euro-denominated cross-border payments require the involvement of 5+ correspondent banks.”
As a result, cross-border payments would be costlier than domestic payments.
Impact on the unbanked
Researchers are also anticipating adoption to positively impact unbanked people – a population of 1.4 billion worldwide.
Unbanked people can’t access standard financial services.
In addition, they have no way of building a credit history, which could lead to higher separation from their wealth.
The introduction of the tech could eliminate the disparity via wallets developed to fulfill essential financial services (holding, sending, receiving funds), creating credit histories, and providing credit scores.
“A CBDC that is accessible to those with bank accounts and smartphones would increase the banked population from 93.5% of households to 96.7% in the US,” the report said.
“Removing the need for a smartphone would increase the banked population to 98%.”
Stablecoins
The report also covered how stablecoins could affect CBDC adoption, noting the growth in stablecoin transaction volumes in the last two years reaching $7.9 trillion in 2022, saying:
“The proliferation of stablecoins for cross-border and domestic payments and transfers could inhibit a central bank’s ability to implement the monetary policy if growth remains unchecked and unregulated, as well as increase systemic risk.”
“In some cases, loss of monetary control could lead to inflation significantly above current central bank targets.”
Due to the excellent performance of their control over some traditional financial systems, analysts say they expect stablecoin adoption and payment use to increase in CBDC’s absence as institutions “explore digital asset custody and trading solutions.”
If CBDCs issuance takes too long, researchers are concerned stablecoins could proliferate further into cross-border and domestic payments.
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In addition, allowing stablecoins to become entrenched increases systemic risk in the traditional market.
It also impedes a central bank’s power to implement monetary policy.
The report also talks about stablecoins and CBDCs coexisting.
According to analysts, stablecoins will continue excelling in some use cases when smart contracts are used.
However, researchers also doubt stablecoins’ longevity.
“CBDCs’ design and programmability will likely determine the level of future stablecoin adoption and usage,” said the report.
“We also note that the potential for CBDCs to displace stablecoins largely depends on the former being interoperable with blockchains and blockchain-based applications.”
Bank risks
The Bank of America analysts cite the potential competition between Bank of America and the central bank as the most considerable risk to CBDC.
“CBDCs are in some ways superior to bank accounts as stores of value, particularly during times of crisis,” explained analysts.
Commercial and central banks exist in a two-tier system, and CBDCs might blur the demarcation lines.
Meanwhile, analysts rate bank runs occurring more frequently next if safeguards aren’t part of the CBDCs design.
“During times of stress in the banking system, people could withdraw deposits and exchange them for CBDCs, given that there is no credit or liquidity risk if distributed with the direct and hybrid approaches, increasing financial stability risks.”
Researchers are dealing with the potential collapse of the commercial banking industry and two crucial questions: how will the general population be swayed into using CBDC? What will governments be capable of doing if they can convince them?
Analysts admit that large-scale policy rollouts will be done in steps and could be prone to controversy and mistakes.
Countries using CBDCs
As of now, eleven countries are using CBDCs.
Meanwhile, the largest central banks worldwide are still exploring designs or launching pilots.
Analysts say the first wave was designed for retail banking use.
They were issued by central banks of developing economies for broad financial inclusion where there were no commercial banking sectors.
The Eastern Caribbean Central Bank’s CBDC faced a significant setback when the platform crashed in January last year and could not operate transactions for two months.
Analysts say that adopting the ECCB CBDC has been uninspiring thus far.
“Issuance and adoption are not synonymous,” they wrote. “And adoption is not guaranteed.”
Privacy concerns
Central banks are following the success and downfalls of the inaugural class of CBDCs.
Meanwhile, central banks and governments are preparing for the next-gen CBDCs’ launch, and the Bank of America analysts are worried that the adoption could lead to backlash regarding privacy.
Potential headwinds could lead to the loss of privacy and anonymity the public enjoys through physical cash.
“Payments using CBDCs can remain anonymous if a legal framework exists. Providing a central bank or government the right trace transactions if there are indications of criminal activity, tax evasion, money laundering, or terrorism financing.”
“But purely anonymous payments are anathema to central banks.”
Researchers also emphasized that perceived or legitimate invasions of privacy could push the public to weigh in on policy initiative, resulting in higher demand for stronger legal protections for CBDCs.
