It’s true, one look at the digital cryptocurrency environment today will reveal bitcoin, Ethereum, and a few of the other consistently top performers. Although each coin is very different, they do have one thing in common. The government or any of the central banks don’t manage them. But, that might quickly change. There are several compelling reasons for governments to join the ranks and create their own cryptocurrency. We’ve listed some of the most compelling below.
But first, what would a digital government currency look like in practice?
An introduction to a CBDC
A central bank digital currency (CBDC) is a digital currency backed by a government’s central bank. In technological make up the currency resembles a combination of bitcoin and government-backed fiat currencies. Since the government backs the asset, they remain liable for your assets instead of a private institution like bitcoin. But in contrast, it is also different from established currencies since it uses the blockchain as a new payment technology.
The central bank’s distributed ledger technology (DLT) will be slightly different from today’s cryptocurrencies. Currently, bitcoin uses a permissionless blockchain, so anyone in the network may run the software and send transactions without being turned away. Since a government entity runs a CBDC, the setup would only allow certain entities to access the blockchain and what they do with it.
Another important note to consider is that a CBDC is not a digital representation of money, such as a traditional banking platform. It is money that is issued directly from the central bank.
Benefits of a CBDC
With this picture in mind, there are several key benefits for governments to explore a CBDC. Some of the most well-known advantages are:
Money is a means of control
Currently, governments manage fiat currencies through central banks with monetary policies. Each monetary policy dictates how money is moved from one place to the next and can be particularly effective for tracking citizen activity. Furthermore, consider what would happen if most of the population turns to a digital currency that the government does not back. The government, in a sense, loses some control.
In the world of digital currency, users don’t need the existing banking system; they use a private exchange like CryptoExchange.com.The blockchain, a digital space, manages the transactions between the buyer and seller rather than a central party. Since no intermediary is needed, there is no need for the central bank or the traditional banking system as we know it today.
With bitcoin’s rapid growth, other projects like libra, the Facebook-backed currency. As this currency gained popularity, government institutions wondered if a powerful company had the potential to challenge their control.
Stay current or get left behind
As cryptocurrencies continue to gain popularity, many new users have taken the leap and started interacting with digital currencies. As the concept becomes more popular, central banks will have no choice but to adapt or face the consequences of being overlooked completely.
Reduced costs and greater efficiency
Since a CBDC will be structured like bitcoin, transferring payments without borders will be significantly more cost-effective. Many also believe that digitizing will allow financial entities to be more connected, making a smoother way to move money around than the complex financial system that currently exists today.
CBDC’s will also improve financial inclusion for the unbanked population since there is no need for consumers to have a bank account to hold digital currencies. In Kenya, we can see the impact of inclusion as evidence from M-Pesa releasing its payment platform in 2007. The country later reported formal finance grew to 83% just a few years later from the initial 14% in 2006.
DLT provides permissioned users with a complete record of transactions, making financial activity more traceable. Currently, illegal activities like money laundering and drug trafficking require untraceable ways to move money. So added surveillance may cut down crime as a result.
That said, Governments like China, who have a reputation for high surveillance, may take this information one step further and use the added tracking to keep closer tabs on their citizens. One example of this is issuing a federal credit score based on a citizen’s earnings and debt levels. The government could theoretically prohibit their citizens from making additional purchases until they pay off their debt. These practices are not standard across all countries. In comparison, the U.S. has discussed preserving their citizens’ privacy if they move forward with their CBDC.
It’s a race
Many analysts view the race to create a digital currency as the space race. Development in CBDC development is likely to spark innovation in all other industries, boosting a country’s technology overall. Like other businesses, many countries believe a first-mover advantage also exists, resulting in international parties adopting the digital currency and further internationalizing the country’s currency, driving the price of the dollar upwards.
Countries leading the CBDC pack
We don’t know how many countries are exploring CBDC’s. However, in a 2020 survey, the Bank for International Settlements asked 66 central banks if they were working on a digital currency. 80% of these banks said they were just exploring the idea, and 10% said they were close to launching it to the general public.
Among the most innovative countries is China. Back in April 2020, Beijing shared its plans for a pilot program for a homegrown electronic payment system. China is now entering its final testing stages for their Digital Yuan. Other countries like South Korea and Brazil have shared that the public can expect their digital currencies in 2023. After advancements made by China, the United States began feeling the pressure despite having previously emphasized they would rather get it right than win a global race towards digital currency.
Impact of CBDC’s on the cryptocurrency industry
With the government adopting central bank digital currencies, many wonder about the impact on existing cryptocurrencies like bitcoin. It’s true; we can’t say for certain, although many believe that CBDCs will promote financial inclusion and make existing currencies easier to purchase and invest in. Governments will provide new parties with an easy way to set up their first digital wallets and get a first-hand look at some of the advantages of digital currency. In turn, many might begin to understand the concepts of digital currency and look for other opportunities to “buy in.”