Written by: Konstantin Anissimov, Executive Director at CEX.IO

Central banks are increasingly looking into CBDCs (in fact, 65% of the BIS’s respondents are actively researching state-backed crypto).

Now the question is: what benefits does a central bank digital currency provide to the state, and how would a CBDC impact Bitcoin and the current banking system?

Konstantin Anissimov, Executive Director at the international cryptoexchange CEX.IO, answers this question and gives his opinion as to how central bank digital currencies could influence the world going forward.

Why Do Governments Need CBDCs?

Governments seek to update the technology behind money to make their economies more efficient. And, taking the cryptocurrency market’s fast growth in recent years into account, the states may have found what they were looking for in blockchain, the underlying tech powering digital assets.

According to available data, digital assets have a combined market cap of over $550 billion, which has been steadily growing since the end of 2018’s bear market. And, based on Mordor Intelligence’s forecast, the industry’s expansion is expected to keep going with a 60.2% compound annual growth rate (CAGR) until 2025.

As large corporations – including IBM, Microsoft, Samsung, and recently PayPal – have been experimenting with some form of blockchain technology or cryptocurrencies, it’s now the time for the state to pilot the tech’s potential use-cases with CBDCs.

What Are the Advantages and Downsides of CBDCs?

Unlike cryptocurrencies like Bitcoin and Ethereum, that operate via blockchain networks in a decentralized way, a CBDC is a state-issued and controlled digital asset that is tied to the value of a nation’s fiat currency.

While a CBDC features the same benefits as a cryptocurrency – such as rapid, inexpensive transfers, increased transparency and traceability, as well as high security –, it will most likely use a permissioned version of distributed ledger technology (DLT) to retain the state’s control of the network.

As a result, central banks have increased control over money issuance, while CBDCs could provide real-time insight into their citizens’ personal finances. We will have to wait and  see to which level governments will want to see the personal state of finances. 

One of the key advantages for the governments here is the ability to see the real-time macroeconomic situation of a country. In most developed market economies this process can currently take between 18 months and two years, which certainly makes monetary policies less effective. In many ways, this would give the best of both worlds: free market economy efficiency with oversight and potential control levels of a state-planned economy.

This move will definitely have its downsides, such as potentially depriving users of the privacy they normally enjoy when using cash. Having said that, though, cash is likely to disappear in the near future and cryptographic assets may provide better consumer privacy protection than the current money alternatives.

On the other hand, CBDCs allow the state to combat illegal activities, payments fraud, money-laundering, and terrorism financing more efficiently. Combine this with a more advanced, systematic taxation system built around state-backed digital assets, and we already see how significant are the benefits CBDCs can provide for governments.

Furthermore, a CBDC is a viable solution to offer financial services to the unbanked. At the same time, state-backed digital currencies have the potential to replace today’s obsolete cross-border networks with an efficient system that features near-instant transfers at inexpensive costs.

Since CBDCs will have similar cryptographic encryption as Bitcoin or other decentralized digital assets, states won’t have to worry too much about cybercriminals’ attempts to counterfeit state-backed crypto.

Also, while thefts may occur – using proven tactics from the cryptocurrency industry like phishing –, it will be much harder to steal CBDCs from citizens than cash.

How Will CBDCs Impact Banks?

Banks have been the major beneficiaries of the current global payment system. Traditional financial institutions have been charging high fees for account maintenance, processing card transactions for merchants, and currency conversions.

However, a central bank digital currency may change this. Due to DLT technology, CBDCs will feature a more efficient payment system, where there is no or only limited need for intermediaries.

As a result, state-backed digital assets provide an inexpensive way for citizens to transfer funds. From the banks’ perspective, this is certainly bad news, as they will be forced to operate on smaller margins. And the less fees they collect, the more revenue they miss out on.

All of this, of course, will only happen if a government makes a decision to issue the digital currency directly to the population. This is not a defined certainty, as there are many ideas currently in discussion and some suggest that CBDC would only be issued as far as the high street banks.

In this case, the government would gain macro level insights and controls, while at the same time not needing to change anything for the retail/consumer sector with regards to privacy and accustomed payment and transfer methods. This would also protect the banks, which are important allies and partners of the central banks in most countries.

We shall have to wait and see which of the possible roads are taken by which governments.

Will CBDCs Become a Threat to Bitcoin?

It may sound counterproductive at first, but most likely CBDCs will have more positive impacts on cryptocurrencies than negative.

While the digital asset industry is heading in the right direction, it is still a very new market, and we have to wait at least a few years until crypto reaches mass adoption.

However, central bank digital currencies can speed up this process.

After the launch of a CBDC, citizens will get familiar with the technology. As they keep using digital wallets for their personal finances, consumers won’t see crypto as some kind of “alien tech” they don’t know. Instead, they will start to embrace the technology and, in the natural course, experiment with multiple decentralized coins.

Furthermore, due to the high privacy levels cryptocurrencies provide, consumers will flow to the digital asset space in large numbers to find closer to cash alternatives.

CBDCs: the Road to a New World Economy

With such a massive interest in CBDCs, state-backed crypto is soon to become a reality.

While governments will use this opportunity to increase their control over their citizens’ finances, in exchange, CBDCs will make the world economy more stable and efficient. Financial institutions will be forced to innovate and take more-consumer-friendly approaches, and the unbanked will finally get access to digital payment services.

And we shouldn’t forget Bitcoin, which will attract millions of privacy-sensitive CBDC users.

However, the road to CBDCs is a tough one, and central banks have to dedicate much of their resources to create efficient state-backed crypto systems.

The important thing is that the technology, governments, banks and regulatory frameworks are all very close to being ready. It will be surprising not to see further acceleration of the CBDC projects in 2021.

Konstantin’s BIO:

Konstantin Anissimov, Executive Director of the international cryptocurrency exchange CEX.IO. Graduated the Executive MBA program at the University of Cambridge. His area of responsibility at CEX.IO includes customer relationships with institutional and VIP-clients, overseeing the creation of the company’s development strategy, new products, markets and partnerships. As a member of the board of directors, Konstantin is also responsible for corporate governance.

Featured image via Unsplash.