CBDCs: What you need to know! - YouTube

Dear friends.

In this episode of your FinTech CapsuleTM Explainer Series,

I’ll cover a topic that is being actively discussed today –

central bank digital currencies, or CBDCs for short.

I’ll explain what they are, where we are in their development

and why this matters – not only for central banks,

policymakers, and banks, but also for you as the end user!

Here we go!

To start, what is a CBDC?

A CBDC is a new digital form of central bank money,

equal to physical cash

or reserves that your commercial bank holds at the central bank.

But wait a second.

You may say that you already have digital cash,

since everything you use,

from your credit card, to your favorite payment app

to a basic bank transfer, involves using digital money.

Well, not quite.

Yes, those online transactions and payments are digital.

But in reality, they are just debits and credits,

or say pluses and minuses, between two different providers,

like banks to payment companies.

Real central bank money is a component of the monetary base

and a direct liability of the central bank.

Today, that practically exists only in two forms:

first, is the physical cash

that you can hold in your hands and that you can see.

The other, which you don’t see,

are the reserves that your bank holds at the central bank.

CBDCs could constitute a third and new form of central bank money.

And that is a big deal.

It is important to understand that there are two major types of CBDCs.

First, is what we call Wholesale CBDC,

which would be used to facilitate payments

only between banks and the central bank,

or other entities that have accounts at the central bank itself.

A lot of work has been done on this in recent years,

from Canada and South Africa to Hong Kong and Thailand.

Whilst the development of Wholesale CBDC is important,

it does not affect you directly, as a member of the public.

It relates more to the piping of the transfer of money

between banks and central banks that takes place behind the scenes.

The second type of CBDC is what we call Retail CBDC,

which can be used by the public and businesses for everything

from payments to savings, very similar to bank notes today.

And this is a complicated topic,

and it has numerous implications from financial stability to financial inclusion.

For this reason, a lot of central banks and policymakers

had pushed off exploring Retail CBDC to the far off future.

But then, Facebook’s Libra was announced in June 2019.

That brought Retail CBDC to the top of the agenda

for all major policymakers and central banks around the world.

Basically, no central bank

wants a Facebook-backed currency or any other form of private money

to be created that could potentially threaten

the existing forms of money issued by central banks.

Over the last couple of months,

there have been numerous papers or experiments

done on retail CBDC from various countries, from the UK and China

to the Bahamas and Cambodia.

Also, numerous global policymakers like the BIS,

the FSB or the FATF have published papers on this topic.

So you may wonder,

what are central banks thinking when it comes to Retail CBDC?

Whilst central banks generally

are not big fans of decentralised cryptocurrencies like Bitcoin,

as they cannot control the total supply as they do with traditional money,

there are some features of Bitcoin

and cryptocurrencies that central banks love.

First, they allow for better monitoring and visibility

of the economic activity in the country.

Today, the central bank has no visibility

on transactions made with cash.

Whilst this is great for businesses who are trying to avoid paying taxes,

this is not great for the broader monetary

or fiscal policy of any country.

With a CBDC, the central bank would be able to see,

to a certain degree,

all transactions carried out and thus be able to reduce financial risk.

Second, CBDCs offer a great fighting chance against money laundering.

Today, a physical bank note represents

the most private and anonymous method of payment,

and it is not a surprise that it is still used a lot for illicit acitvities

from drug and human trafficking to money laundering.

A CBDC could, for the first time,

give us a fighting chance against money laundering.

It’s a massive global problem.

It’s estimated that the amount of money laundered each year

represents between 2-5% of global GDP, according to the United Nations.

Third, CBDCs can help with financial inclusion,

especially in difficult times

like we are going through with the coronavirus pandemic.

As people shy away from using cash,

worried that dollar bills and coins could carry the virus,

two categories of people are negatively impacted:

first, the elderly, who tend to be less tech-savvy

when it comes to digital payments,

and second, those who are unbanked or underbanked,

as they don’t have a bank account or access to formal financial services.

Because they don’t have a bank account to send to,

many governments around the world are having trouble

sending COVID relief funds to the unbanked or underbanked,

despite the fact that they are often the people who need it the most.

For example, it was reported that the U.S. IRS

had to send over 100 million COVID-19 relief cheques by mail.

With a digital CBDC, money can be sent easily to everyone.

For example, to a CBDC digital app

or wallet that can be installed in every single smartphone,

thus allowing the government to send out funds quickly and effectively.

And, a blockchain-based CBDC

allows numerous new possibilities that are not possible today,

from having programmable money via smart contracts that allow us

to input monetary policy, like interest rates, directly on the CBDC

to being able to do micro-payments seamlessly,

in a world connected by Internet of Things devices.

Whilst this is very exciting and truly shows the potential

of the future of money, there are potential downsides as well,

especially for traditional financial institutions.

First, there is the risk of disintermediation of banks.

If you replace your $1 banknote with a $1 CBDC,

the impact is limited.

But, if the public starts substituting their bank balances with CBDC,

then this reduces the bank balances that banks hold,

increases their funding cost, and reduces their profitability.

The bigger risk for central banks is that in the event of a crisis,

a CBDC can accelerate a run on the banks.

For example, today, if you do not trust the banking system,

you can go to an ATM and withdraw all your money in cash.

However, there are physical limitations

to how much you can withdraw from an ATM,

let alone all the practical challenges with how you will secure

and keep these banknotes safely.

In a CBDC world, you could quickly remove your funds held at your bank

and hold them in your digital wallet.

And unlike paper bank notes,

there is no limit on how much you can store digitally!

Central banks (and your bank!) are fully aware of this risk,

and this is why many CBDC initiatives

have tried to put various restrictions,

from a maximum amount of CBDC that someone is allowed to hold

in their CBDC wallet, to having a lower interest rate

on CBDC than for bank deposits, so people have an incentive

to keep their money in traditional banks.

The other concern is privacy.

Whilst having the central bank be able to see all transactions in a country

is great to combat money laundering or corruption,

it also raises privacy concerns.

So, expect to see a lot of activity in this space over the coming months.

I’ll try to cover them as best as I can

to keep you all posted in my weekly Crypto CapsuleTM vidoes

or my weekly Future of Money newsletter.

You see, who said that the future of money was not exciting!

If there is any topic you want me to explain,

or any question you want me to answer,

feel free to let me know in the comments below.

I hope this was a useful video,

and stay tuned for another Fintech CapsuleTM Explainer Series soon.