The exponential growth in cryptocurrency space has seen the technology surged from a fringe technology to an integral element of discourse in financial markets. Central banks and regulators across the globe have been watching the space closely. The value of cryptocurrency markets surpassed $2 trillion earlier this year and interestingly, the use of stablecoins have soared. Stablecoins are cryptocurrencies tied to a variety of stable underlying assets, so their prices do not move. The most popular stablecoin, Tether (USDT) has a $65bn market capitalisation. Consumers are not using cryptocurrencies solely for quick gains but also as a store of value and a safe haven from volatile cryptocurrency markets.
Some countries have embraced cryptocurrencies with open arms. El Salvador became the first country to accept Bitcoin as legal tender. Others have sought to clamp down and expel them. China recently banned cryptocurrency mining and banned financial institutions from providing services for crypto related transactions. Regardless of their stance, all countries have seen opportunities. The success of the blockchain technology that underpins cryptocurrencies has piqued government interest. Now, several governments have created Central Bank Digital Currencies (CBDCs) and the UK itself is considering launching its very own “Britcoin”. China has trialled its own digital yuan in specific regions. Japan, Sweden, and Dubai have also launched their own CBDCs. In total, over 80 countries are exploring the option of issuing their own CBDCs.
Notably however, CBDCs are not and will not be cryptocurrencies. Some central banks may adopt blockchain technology, but none will be decentralised as they will be issued and monitored by central banks. Some may not even run on blockchain and could use other forms of distributed ledgers. All of this hype begs the question, why are governments so keen to launch their own digital currencies? This article will explore the possibilities and potential problems with widespread consumer adoption of CBDCs.
The underlying technology means that CBDCs will provide much greater financial transparency for governments along with faster, cheaper, and more secure transactions for consumers. Unlike cryptocurrencies that operate in a decentralized manner on blockchain, a CBDC is a digital representation of a country’s fiat currency. They are issued by, and transactions can be monitored in real-time by the central bank. For retail customers, CBDCs can be issued directly into pseudonymous wallets, similar to cryptocurrency wallets. Alternatively, the currencies can be paid into token accounts which can be set up with full identification. As discussed below in China’s trial, there is the possibility of tiered accounts where users have high account limits based on the level of information provided.
A potential benefit of CBDCs is that they provide central banks the ability to pay funds directly into citizens’ accounts. Currently, central banks use commercial banks to help issue funds to citizens where necessary. In times of crisis, such as a pandemic, CBDCs can provide a faster and cheaper way to provide relief directly to citizens. With CBDCs, central banks would save millions in commercial bank fees. Additionally, shifting the society away from cash towards CBDCs would reduce the costs of supplying and maintaining cash in circulation. These costs can amount to 2% of GDP for developed countries. Although, the UK government has said any CBDC it launches would operate alongside cash and bank deposits, rather than replacing them.
For consumers, having the central bank process payments via CBDCs reduces exposure to banks and credit card companies. In the 2008 financial crisis, consumers collectively lost billions in deposits and analysts are increasingly concerned about the possibility of another financial crisis. Central banks by their nature cannot go bankrupt, so CBDCs would limit exposure to collapses of private financial firms. Although we must note, consumer protections in financial services and bank stress testing have increased exponentially since the financial crisis.
China’s trial of its own digital yuan provides an insight to what CBDCs could look like in large economies. The Chinese government hopes the digital yuan will be in use at the 2022 Winter Olympics. A variety of services will accept the digital yuan such as self-service vending machines and unmanned supermarkets. The currency will give the government complete control and transparency over all transactions of its citizens. Digital yuan wallets will be tiered based on the amount of personal information provided. The tiers will determine transaction and balance limits. Users will be able to open basic wallets without providing any personal information but can provide information later to upgrade wallets and unlock features. It first ran a trial of the currency in the Shenzhen region in 2019 but later expanded this to 11 cities and provinces. The total value of transactions using the digital yuan reached 34.5 billion yuan ($5 billion) by the end of June 2021.
While the e-yuan was designed for domestic use, the Chinese government is exploring the possibility of cross-border payments for the currency. China’s yuan only accounts for 3% of global payments, a figure the Chinese government is keen to change. The e-yuan is part of a plan to internationalise the currency and combat the US dollar’s international dominance. These ambitions have alerted Western powers who worry about China’s growing economic might. While Western citizens will be in no rush to use the digital yuan, China’s smaller neighbours in the far-east, subcontinent and Australasia could turn to the digital yuan as a payment method in the future.
One important takeaway from China’s trial is the risk of consumer indifference. Bloomberg1 interviewed users of the digital yuan and found that most people who had trialled the currency were not excited by it and were not keen to adopt it. There are simply too many other reliable alternatives and insufficient incentives for people to take up the e-yuan. The two major online payments systems in China, Tenpay (incl. WeChat Pay and QQ Wallet) and AliPay, hold more than 90% of the mobile payments market. This parallels Western markets where several digital payments providers operate. China’s authoritarian government could, however, eventually force widespread adoption of the currency, if this furthers national interests. China’s trial provides a strong insight into how citizens of large, developed economies may view CBDCs and their potential for widespread adoption.
There are several obstacles to widespread adoption of CBDCs in Western societies. A big limiting factor is that CBDC’s cannot compete with or replace cash, at least in the short term. Use of cash in large economies is declining but it still makes up a large part of the monies in circulation. The average value of cash in circulation is 10.7% of GDP in the Euro area and 20% in Japan2. Cash still plays an important role in our economies and provides a level of freedom from scrutiny that CBDCs certainly do not provide. This automatically limits the potential widespread adoption of CBDCs as they can only effectively compete with other digital payment services.
Secondly, over the past two decades, we have sleepwalked into handing every detail of our personal lives over to technology and financial firms. There remains however, particularly in Western societies, widespread resistance to providing the state with additional access to our personal data. The act of openly giving the government direct real-time access to our finances is a concept many people find objectionable. The millions of small merchants who operate on a cash basis would certainly look to avoid giving the government real-time access to their income details. Governments, understandably, are keen to improve economic transparency but concerns of privacy would create some resistance. These privacy concerns would be a major obstacle to widespread adoption where Western governments want citizens to use CBDCs in their daily lives.
Fundamentally, however, the biggest obstacle to widespread adoption of CBDCs is that they are too late. We have an array of digital payment tools from CashApp to PayPal to ApplePay. As was seen in China’s case, there was a sense of indifference to their digital yuan. There’s nothing particularly ground-breaking about these CBDCs and most people already have easy and reliable means to carry out digital payments. Stablecoins perform well as they operate within the cryptocurrency sphere and provide shelter from the volatile markets. CBDCs will typically operate outside of this sphere and will be in competition with other digital payment services. Therefore, for individual consumers, the appeal of CBDCs appears limited.
CBDCs are undoubtedly an important advancement in financial technology but in Western economies they are unlikely to be widely adopted, in the short term. There are too many strong competitors for CBDCs to overtake as a payment method. While China saw billions of dollars worth of transactions carried out in trials, it is unclear whether there is genuine appetite for the e-yuan.
For central banks however, CBDCs constitute a sound new tool for them to implement policies, particularly in times of crisis. In the long term, there is every possibility that CBDCs could be a primary form of payment. For decades, payments by cheque were front and centre. The idea that the nascent chip and pin cards could replace cheques was inconceivable at one point. As of 2020 however, cheque payments accounted for less than 1% of all UK retail bank payments3. The use of CBDCs indeed could become the main form of payment method within a few generations. For now, however, governments will continue to explore CBDCs and determine the best way to implement this promising technology.