Traditionally, central banks only issued physical currency notes and coins, and their payments operated through the central bank reserve system. With technological advances, digital payments have evolved, and alternative payment methods such as credit cards, e-wallets, and mobile payments have disrupted the traditional cash-based payments system. Thus, central banks are trying to keep up with the trend, trying to digitalize their monetary policy.
CBDCs involve transferring central bank liabilities into digital form, making it easier for central banks to track transactions and reach the population. CBDCs have the potential to reduce the overall cost of cash circulation and increase transparency in the financial sector. Moreover, they can create new economic opportunities, boost financial inclusion, and enhance the central bank’s monetary policy effectiveness.
In economies with significant informal cash transactions, CBDCs can offer new levels of financial inclusion. Online banking solutions could eliminate the need for intermediaries and be accessible to everyone with a smartphone, making financial transactions cheaper and more secure.
However, there is growing concern around CBDCs and the power they could give central banks. If a nation’s entire financial system is digitalized, central banks will have the ability to track all transactions, eliminating anonymity and potentially posing privacy concerns. Though in a centralized monetary system, CBDCs would reduce the risk of money laundering and black-market transactions.
Furthermore, CBDCs could provide central banks with an effective tool to implement negative interest rates in times of economic distress. In a financial crisis, the central bank usually cuts interest rates to stimulate economic growth. However, in times of uncertainty, interest rates can only go so low, which leads to the idea of negative interest rates, where banks would pay borrowers to take out loans, essentially charging savers to keep their money in the bank. CBDCs would make this possible, where the central bank regulates an economy in its entirety. Yet, this proposition will not be welcomed by the banks, and any such step could lead to bank failures.
CBDCs are still in their development stage, and various nations are currently working towards centralizing their digital financial systems. In conclusion, CBDCs could be the future of money as they have the potential to offer many benefits. However, they must be developed and implemented with caution, making sure that they are a secure and reliable form of currency that encourages financial inclusion rather than exclusion.