Last updated on July 9th, 2023 at 06:57 pm

The question of whether or not CBDCs should be introduced continues to be debated around the world, even as a handful of countries are already going ahead with their introduction. In this piece, we examine some of the questions people are asking regarding the potential implications of CBDCs. Some argue that CBDCs have the potential to transform businesses while also accelerating the economy of things, enabling a secure transition to a digital future by leveraging digital money’s capabilities. This, together with the growth of the digital economy, ensures that citizens’ faith in the value of money is sustained.

On the other hand, some argue that CBDCs pose crucial downside risks for privacy (by enabling the surveillance state), the availability of cash and might have negative implications for the banking industry. See DeFi Planet’s article, The Implications of CBDCs For The Banking Industry, for more information. 

Are CBDCs good for Financial Inclusion?

The present monetary system is such that not everyone can open a bank account. Especially in countries with developing markets, financial institutions and services, are not accessible to everyone, thus people are left depending on cash or barter systems. In such systems, people often need to turn to collateralized loans and non-traditional institutions (including predatory ones) when they need to borrow money for instance. Some countries with advanced financial institutions have hurdles like a minimum required deposit, personal identification, and even access to the internet or a local branch. With the financial systems becoming increasingly digital, developing and already developed economies might be left behind if they are unable to meet a certain target of bank accounts.

Even among citizens who have bank accounts, many do not have complete access to all financial services and are in effect, underbanked. According to a 2019 report by the U.S. Federal Reserve, 22% of American adults (63 million) are either unbanked or underbanked. The 16% of Americans who are underbanked have some sort of bank account but also rely on alternative financial services. On the other hand, the 6% who are unbanked have no bank account and rely on alternative financial services like payday loans, check cashing services, money orders, and pawnshop loans to support their financial needs.

Retail CBDCs have the potential to deal with the problem of access to financial institutions, by making them more accessible than they currently are. Retail CBDCs are issued by a central bank directly to people without going through the traditional bank accounts where you might need to physically go to open the bank account. In this system, individuals will have CBDC accounts directly on the main central bank ledger, accessible via a wallet (which may or may be private or public sector operated). After which they have access to the money in these accounts. The transaction is done through a digital wallet application that is linked to the CBDC account via the Application Program Interfaces (APIs). CBDCs could replace or provide an alternative to fiat cash, potentially addressing several problems currently faced by the unbanked and underbanked communities. Retail CBDCs can do this by establishing a more inclusive digital payments ecosystem and creating financial data identities. However, the extent to which CBDCs may play this financial inclusion role will depend entirely on their design features and the parameters they set for access. To be effective, CBDCs will have to intentionally, as a matter of public policy, ensure that their requirements (e.g. in terms of documentation, minimum balances or income, etc.) are lower than those of commercial banks in the given country; otherwise, the same financial inclusion barriers will remain.

Will CBDCs provide Programmable Money?

When discussing programmability, it is critical to distinguish between programmable money and programmable payments. The two terms are distinct even though they are often used interchangeably. 

Programmable money limits the user by its built-in parameters. These software-coded regulations can imply many things, for example, the money has a defined expiration date or its usage is limited to items of a specific nature. This would have an impact on digital money acceptance and may even have legal and social consequences.  For example, a government-funded disbursement may be designed to be used for sustenance goods only e.g. food and water, and be barred from being used for discretionary goods such as gambling or alcohol.  This has social, public policy, and legal implications even if these are not new concepts.

Programmable payments, on the other hand, allow automated transactions to be performed or prevented based on the conditions that are fulfilled. These might include daily spending limitations or recurring payments. These can be comparable to direct debits or standing orders but with the ability to handle additional complexity and conditionality. Programmability characteristics might provide several benefits, without having to change the currency’s attributes, such as allowing new workflows, procedures, and digital business models.  Smart contracts used in the burgeoning decentralised finance (DeFi) sector are an example of the usefulness of programmable money.  

At its most fundamental level, the ability to schedule payments and attach conditionality increases convenience and efficiency for a wide variety of stakeholders and use cases. It would be useful for CBDCs to have programmability as a feature, but the programmable logic should arguably be placed outside of the asset. Financial service companies may rely on central banks’ infrastructure for the underlying currency but also use the CBDC as part of more complex transactions. 

See DeFi Planet’s article, The Implications of CBDCs for the Crypto Industry, for a broader context.

Impact on Privacy – Will CBDCs enable the Surveillance State?

CBDCs are believed to improve economic efficiency, yet, one of the major concerns that people have with them is privacy. 

There is a good chance the private information of citizens holding retail CBDCs could be exposed. This is the issue with storing massive amounts of information in a centralised system. The transparency, traceability, and privacy implications make CBDCs a double-edged sword. 

There is also the question of whether central banks would be allowed to disclose transactional information with other government agencies and whether CBDCs will be used to track the spending habits of people in general or even of a certain segment of society.

To achieve their potential, users need to be certain that CBDCs are just a digital form of their existing fiat currencies with no usage limits or invasions of privacy.  However, it seems likely that once governments have this data and programmable control, they will inevitably use it in the same ways that governments currently use their citizens’ data i.e. both to provide beneficial social services and to carry out oppressive acts.

Do CBDCs have implications for Cash?

As highlighted above, CBDCs aim to provide financial security and privacy while also easing transferability and accessibility. Cash requires a significant amount of labor and cost in terms of maintenance, cross-border transaction costs, and so on. With this in mind, it appears extremely likely that CBDCs will soon replace cash because of the convenience that it provides.

In an interview with CNBC, Eswar Prasad stated that the age of cash is coming to an end and that the era of central bank digital currencies has begun. He further predicts that cryptocurrency, stablecoins,(CBDCs) and other digital payment systems will lead to “demise of cash.” 

Conclusion

• Central banks throughout the world are considering the introduction of CBDCs. 
• Compared to traditional fiat money, CBDCs have significant advantages for consumers in terms of liquidity, scalability, acceptability, convenience, and much more efficient settlements.
• CBDCs allow the attachment of conditionality to payments and monetary policy, thereby increasing convenience and efficiency while giving the government significant control over a country’s money supply and compromising citizens’ privacy.

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