Once considered radical, electronic currency is more mainstream than ever. The rise of e-currency has been dramatic, fueled by blockchain and bitcoin, and seems to be poised for penetration into greater world relevancy.
While private digital currencies have thrived in recent years, central banks are just beginning to catch up. In 2021, El Salvador adopted Bitcoin as its national currency. Countries like Nigeria, the Bahamas, Eastern Caribbean States, and Cambodia have become some of the first countries to launch Central Bank Digital Currencies, or CBDC’s.
Currency undoubtedly plays a huge role in the way a country operates, both within itself and within the global marketplace. As we move further into the digital age, how will Central Bank Digital Currencies influence the international trade landscape?
What Are Central Bank Digital Currencies?
A Central Bank Digital Currency is the digital form of a country’s fiat currency, and is distributed and backed by the full faith and credit of the government.
In the United States, there are currently two kinds of central bank money. These take the form of physical currency, such as coins and dollar bills, and digital balances held in bank accounts.
While Americans have held currency digitally for quite some time, Central Bank Digital Currency would be a liability of the Federal Reserve rather than commercial banks.
With other kinds of decentralized digital currencies, such as bitcoin, multiple devices around the world are constantly verifying the validity of a transaction in what is known as distributed-ledger technology. This would not be the case with CBDC’s.
Why Would a Country Implement CBDC’s?
There are many reasons a country would implement a Central Bank Digital Currency, depending on their economic situation. These include:
1. Greater Financial Inclusion
Through the implementation of a central bank digital currency, it becomes easier for unbanked and underbanked populations to access money. Geographical roadblocks to financial services and central currency access are alleviated, and lower transaction costs improve access for lower income households.
2. Increased Competition
Implementing a centralized digital currency creates competition in the financial services and payments market, which may help provide cheaper access to money in addition to incentivising efficiency.
Additionally, the implementation of a CBDC would provide a level playing field for private players to meet current and future demands for payment services.
3. Extending Access to Safe Currency
The implementation of a centralized digital currency would provide consumers and businesses with an alternative to hard currency, whose use is on the decline, that is free of the credit and liquidity risk present in digital bank money.
4. Maintaining International Relevancy
As countries push further into the future, implementing their own centralized digital currencies, it may become necessary for a country to create a central bank digital currency just to maintain relevance in cross border transactions and foreign markets.
What Are the Risks?
One of the main problems associated with the implementation of a CBDC is the potential run on banks that could occur.
Residents could pull too much money from their bank accounts too fast, inhibiting the bank’s ability to loan money and sending a shock through interest rates.
This also relates to a central bank’s ability to help weather economic instability through monetary policy; the Federal Reserve is able to alter interest rates by changing the amount of money flowing through the economy. They do this mainly by setting the Federal Reserve’s administrative rates. The introduction of an interest-bearing CBDC could quickly complicate monetary policy by changing consumer demand for currency reserves.
Additionally, there are various policy and restrictive measures which the CBDC would need to comply with, such as potential anti-money laundering (AML) and combatting financing terrorism (CTF) policy for CBDC’s.
Implications for Cross Border Payments and Trade
It is forecasted that, in the next three years, central banks representing around 20% of the world’s population will issue a general purpose CBDC. What are the implications on such widespread implementation on cross border payments and international trade?
1. Improved Efficiency
Cross border payments, in their current form, suffer from numerous roadblocks which serve to lessen the efficiency of payment processing. These frictions are often extremely costly, involving a great number of intermediaries across different time zones throughout the banking process.
Additionally, cross border payments, as they exist currently, are extremely lacking in transparency and traceability, leading to frictions regarding AML and CFT checks, slowing them down.
Because of the high level of human involvement in the cross border payments process, organizations are unable to take full advantage of technical automation and interoperability.
Central banks could, from the beginning, develop and implement interoperable cross-border CBDC systems, almost entirely alleviating the high costs associated with maintaining a huge number of international intermediaries. Not only would this lower the costs associated with cross-border payments processing, it would significantly speed things up. Whereas human involvement works with regards to time zones, machine involvement does not.
Compatible CBDC systems also provide an additional means to settle transactions in central bank currency across borders. This, coupled with the development of open, competitive CBDC domestic payment processing, could allow for a more diverse group of banks and non-banks occupying the market space, and could reduce fragmentation and concentration in payments.
2. Improved Accessibility For Smaller Players
Smaller corporate entities looking to participate in global financial transactions could have increased accessibility to funds and lower cost transactional implementation methods through CBDC implementation.The increase in efficiency and competition, and the resulting lower costs associated, would greatly benefit smaller players with less capital to throw at traditional banking procedures.
3. Increases in Cross Border Flows
CBDC implementation has the potential to increase cross border flows.Financial markets over the past half century have become increasingly integrated on a global scale. This has supported mutually-beneficial risk sharing, growth, and increased capital flows. However, sudden capital flow reversals due to deteriorating trade relations have often served to harm financial stability.
Cheaper and more accessible remittances and payment settlements will help stabilize the economy and help buffer against economic shocks by facilitating hedging, through an alternate and thriving payment method. This would help ease trade fears, and keep funds flowing across borders even amidst financial instability and faltering trade relations.
4. Improved Global Trade
Cheaper, more efficient payment processing could facilitate the growth in global trade. Additionally, making payments easier and more accessible for smaller players opens up economies for growth potential in smaller, more often overlooked sectors that could then take on a larger, more global role on the economic playing field.This growth in smaller, less globalized sectors could help make the overall economy more robust, better able to weather recessionary pressures and trade fluctuations.
The Future of CBDCs
Much is still unknown about the impacts that CBDCs will have on the global economy. Policy and integration will undoubtedly play a huge role.However, we seem to be moving ever closer to a world where CBDCs are a major part of international trade, and the benefits that they could bring, if done right, remain a shining example of how technology has the potential to change the financial world for the better.
Isaac, this is great! Thanks for being so informative.