Modern central banking has been around since the 17th century. The term refers to the authority responsible for overseeing the monetary system and policy of a nation or group of nations. The three main goals of a central bank are: Stabilizing the economy, stabilizing price or the value of money and financial stability. The bank of England was considered to be the first central bank whose role was lender of last resort. Other central banks such as Napoleon Bank of France and Germany’s Reichsbank, were established to finance expensive government military operations. Top 10 central Banks today by total assets are:
- Federal Reserve System (Fed) - US
- Bank of Japan - Japan
- People’s Bank of China (PBoC) - China
- Deutsche Bundesbank - Germany
- Bank of France - France
- Bank of Italy - Italy
- Bank of Spain - Spain
- Swiss National Bank - Switzerland
- Bank of England - UK
- Central Bank of Brazil - Brazil
The order of this list varies over time as the total asset of these central banks may vary.
Fiat currency (cash) is a government-issued currency, such as U.S. dollar, Great British Pound (GBP) and Chinese Yuan, that is not backed by a physical commodity and is declared legal tender. Fiat currency comes in the form of banknotes and coins.
The use of cash is becoming obsolete as the digitization of money is increasingly becoming popular in our societies today. People presently would rather to use their debit or credit cards rather than to be walking around with cash, and for good reasons. There are many disadvantages to having cash on your person. Some of which are: You could be targeted by thieves, you can lose your cash, it carries germs and cash can be clunky being carried around in your wallet. Using your card offers a long list of benefits that cash does not offer and eliminating the disadvantages of using cash.
In order for central banks to continue to be an anchor of the monetary system, as modern economies become increasingly digital, central banks will also need to revolutionize their payment system. Many countries have played with idea of implementing their Central bank digital currency (CBDC). In fact, several countries have already fully launched a digital currency, while others are still in the piloting phase. A CBDC is considered to be a virtual or digital form of a country’s fiat currency, which is different from balances in traditional reserves or settlement accounts and is a direct liability of a central bank. In other words, CBDC aims at preserving the oligopoly of the global banking system. CBDC exist in two forms:
Wholesale CBDC are intended for settlement of interbank transfer. This is basically transferring of assets and money between two banks, requiring that a payment only settles on condition of delivery of another payment or delivery of an asset.
Retail CBDC entails the transfer of the digital currency directly into customers account.
- Financial inclusion of the unbanked
- Increase speed of settlement and real-time payment with the elimination of intermediaries.
- Prevents illicit activity
- Lower transaction cost
- They can provide the assurance of better anonymity in comparison to the current commercial bank card payments.
- A key concern about a CBDC is the risks of disintermediation of commercial banks since central banks will now be a direct competitor.
- Does not solve the major issue of centralization.
- CBDCs are basically walled gardens because of their geographical restrictions and are accepted only in the country that issued it.
- The customers may have to give up on some degree of privacy since the issuing central bank will have full oversight about what the customer uses their money for.
- CBDCs do not have any links to fiat currency and could showcase higher price volatility.
Cryptocurrencies such as Bitcoin, Ethereum, XRP and stablecoins such as USDC and USDT have become an established part of the financial landscape over the pass ten years. The conceptualization of CBDC happened primarily because of these currencies that are secured by cryptography. The word Cryptography means “secret writing”. According to a definition on Coinbase, “Cryptography is the study and practice of sending secure, encrypted messages between two or more parties. Cryptography allows digital currency transactions to be pseudonymous, secure, and “trustless” – with no bank or other intermediary required.” In cryptocurrency, cryptography assured the security of the transactions and independent of any central authority. It also offer protection against double-spending.
Typical cryptocurrencies like Bitcoin, are decentralized and derived value from supply and demand. Most cryptocurrencies has a built-in scarcity or “total supply” that allows them to have a limited supply and are noninflationary. Crypto transactions are recorded publicly on Distributed Ledger Technology (DLT) known as blockchain which eliminates the need for a central authority. Furthermore, cryptocurrency transactions are borderless which circumvent the wall gardened nature of CBDC. Crypto transactions are inherently processed in a very short period of time with low processing fees. Click link to see major cryptocurrencies deposit processing time. Bitcoin and cryptocurrencies are aimed at offering an approach for escaping banks and hedging against the constant declination in the spending power of cash. Not to mention, democratizing the financial systems.
However, the price of Bitcoin and other cryptocurrencies fluctuates wildly, and some experts say this limits their usefulness as a means for daily transactions.
Stablecoins are cryptocurrencies that are issued across multiple public, permissionless blockchains and are meant to be pegged wholly are partly with a fiat currency or underlying asset such as precious metals. This as a result, eliminates the volatile nature associated with crypto. They are not issued by a central bank but rather by private entities and are designed to enhance liquidity and simplify settlement across the crypto ecosystem. Stablecoins can be sent instantly without the transaction fees associated with credit card or remittance companies such as World Remit or MoneyGram. However, most of the features of CBDC applies to stablecoins.
The utilization of cash in the traditional financial system has been on the downtrend for years because of the many disadvantages to using it. A case for Crypto and CBDC to exist in society and as a part of the financial system is highly evident. There are disadvantages to both but regardless, they offer great benefits and may coexist together. CBDC are geared towards favoring and empowering central banks while cryptocurrencies focus on democratizing the financial system.