Since May 2020, there has been an increase in the number of central banks investigating central bank digital currencies (CBDCs), from 35 to at least 114, representing 58% of all nations and producing 95% of the world’s GDP.
A report analyzed the potential advantages and disadvantages of CBDCs, including those associated with their issuance and those associated with their non-issuance, as well as alternative distribution strategies. The report includes several case studies focusing on the growth and difficulties of CBDC in particular economic blocs and countries.
The current financial system’s outdated infrastructure and various inefficiencies are among the experts’ primary findings—problems that properly constructed CBDCs might immediately address.
According to the paper, the technology will eliminate intermediaries, real-time settlement, total transparency, and lower costs that may result from CBDCs’ ability to do so.
The researchers emphasize that banks must deposit an estimated $4 trillion in capital in equivalent banks in order to eliminate settlement risk. According to the report, this is an ineffective use of capital that could produce a yield in another area.
The research report claims that the requirement to pre-fund accounts at correspondent banks prevents smaller banks and payment service providers from entering the cross-border payments market.
“In reality, cross-border payments are routed through 2.6 different correspondent banks on average, increasing time to settlement. However, 20% of euro-denominated cross-border payments require the involvement of 5+ correspondent banks.”
According to estimates from the U.S. Federal Reserve for 2021, the unbanked population—1.4 billion people worldwide and 6.5% of the population in the United States — will benefit from CBDC adoption.
The unbanked lack access to conventional financial services and avenues for establishing their credit histories. However, they consequently experience more wealth separation, such as when they depend on payday loan services with poor terms and conditions. According to the report, this inequality might be nearly entirely erased if a CBDC wallet were created to provide fundamental financial services like the ability to hold, transmit, and receive funds, as well as generate credit histories and provide credit scores.
To be more precise, the analysis asserted that a CBDC accessible to individuals with bank accounts and cell phones would raise the percentage of households in the U.S. with bank accounts from 93.5% to 96.7%.
As per the report’s authors, the development of stablecoins for domestic and international payments and transfers might make it more difficult for central banks to implement monetary policy and raise the systemic risk if growth is left unmanaged and unregulated. Loss of monetary control may occasionally result in much higher inflation than existing central bank targets.
The analysts claim that they “expect stablecoin adoption and use for payments to expand in the absence of CBDCs as financial institutions explore digital asset custody and trading solutions” because their controls continue to operate effectively in comparison to some traditional financial systems.
The researchers are also concerned about a scenario where stablecoins spread much further into domestic and cross-border payments if it takes too long to issue a CBDC. Stablecoins will “increase systemic risk in the traditional market and impede a central bank’s ability to implement monetary policy” if their adoption is allowed to grow.
“The proliferation of stablecoins for cross-border and domestic payments and transfers could inhibit a central bank’s ability to implement monetary policy if growth remains unchecked and unregulated, as well as increase systemic risk.”
The report considers the possibility of future stablecoins and CBDCs coexisting. The researchers claim that stablecoins will probably keep outperforming other payment methods in specific use cases, mainly when smart contracts are involved. However, the researchers quickly flip a few lines later and opine that stablecoins won’t last much longer.
Undoubtedly, central banks are keeping an eye on the accomplishments and failures of this first class of CBDCs. While governments and central banks prepare to introduce next-generation CBDCs, Bank of America analysts are concerned that widespread adoption of CBDCs could encounter resistance due to privacy issues.
The authors acknowledge that the loss of the public’s right to privacy and anonymity that comes with physical money could be a barrier to CBDC adoption. The research offers a compromise based on policy for this.
The researchers underline that any actual or perceived violation of privacy could cause people to rethink the policy initiative and lead to a rise in demand for CBDCs with more significant legal safeguards.