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Silver is heading for its greatest reinvention in centuries. Modern technology and even the coronavirus pandemic have pushed consumers away from cash, and with alternative concepts like stablecoins and cryptocurrencies taking hold, central banks are moving quickly to ensure that they do not lag behind in terms of innovation. The goal is a form of digital currency that can compete with private sector alternatives by being more secure, resilient and cheaper.

1. What would CBDCs look like?

It’s not that different, at least on the surface, from keeping e-money in a bank account and using cards, smartphones, or apps to send that money out into the world. The main difference is that money provided by a central bank – like cash – is generally considered a risk-free asset. For example, a dollar bill issued by the US Federal Reserve is always worth $1. A dollar in a commercial bank account, although in theory convertible into paper money on demand, is subject to the solvency and liquidity risks of that bank, which means that consumers cannot always access it and may lose money if a bank fails. CBDCs, like banknotes and coins, would be the direct responsibility of the central bank, carrying its collateral.

2. What do CBDCs have to do with crypto?

Not a lot. Even when the value of Bitcoin increased, its use in payment transactions was still limited. The cryptocurrency movement – ​​where groups of private citizens are developing protocols for their own versions of money – symbolizes a revolt against centralized financial authority, while central banks and CBDCs embody it. A possible overlap is the blockchain technology pioneered by Bitcoin, which functions as a publicly distributed ledger of transactions. Some countries are experimenting with blockchain, though experts doubt that in its current form the technology can handle the volume a CBDC could generate. The crypto development central banks most concerned about involve “stablecoins,” which peg their value to an existing currency or asset. Plans announced by the Facebook operator in 2019 for a stablecoin (first called Libra, then Diem, now dead) rattled central banks and accelerated work on CBDCs.

Central banks are experimenting on two main routes: wholesale and retail. In retail applications, consumers could have direct access to central bank digital currency, for example in an existing bank account or through a wallet offered by a payment service provider. In wholesale projects, the focus is on exploring more innovative technologies for interbank payments and settlements, and they are often even experimenting with blockchain. A wholesale CBDC would not be an entirely new concept, however, since central banks are already granting lenders access to digital accounts.

4. How would payments improve?

Digital payments could be settled faster than they currently are – even instantly, eliminating credit risk – and at lower cost. In some countries where electronic means of payment are not widely used due to high costs for merchants, card or telephone payments could become widespread. Additionally, a lower-cost CBDC could foster competition among payment service providers, so even conventional card payments – like Visa or Mastercard – could become cheaper.

5. What are the potential drawbacks?

Denmark and some other countries have ruled out the retail model for CBDCs because traditional banks that support economies by providing loans could be undermined if depositors switch to central bank accounts en masse. Privacy advocates worry about a loss of anonymity and the potential for government surveillance.

The International Monetary Fund indicates that about 100 countries are in various stages of exploration. Nigeria’s eNaira entered circulation in late 2021, India launches its first digital rupee pilot, and in China hundreds of millions of consumers have already used the digital yuan in its trials. Some of the Eastern Caribbean islands that share a central bank have launched their own digital currency, DCash. Its use was extended to Saint Vincent and the Grenadines in 2021 after a volcano erupted; deployment was seen as a key part of recovery efforts.

The Fed has also been lukewarm on the idea. He published an article outlining the benefits, but officials say there will be no “Fedcoin” without congressional action. He did, however, conduct research: In November, an official at the Federal Reserve Bank of New York said a team there had found that a central bank digital currency using distributed ledger technology could reduce the time to settle foreign exchange transactions from two days to less than 10 seconds. Other central banks also say they are building technical capacity, but see no urgent need to act. The Swiss National Bank has conducted what it says are successful tests of digital payments, but officials have expressed doubts whether a CBDC would fill a real gap. Swiss National Bank Vice President Martin Schlegel compared CBDCs to “a wheel whose road has not been built.”

8. Is there a precedent for this?

Not quite, although there are parallels. For centuries, it was common for transactions to be conducted in banknotes and coins issued by individuals, despite the endless headaches caused by fluctuating values. In the late 1800s, many governments seeking greater monetary control gave their central banks a monopoly on issuing currency. Today, with the emergence of electronic cash payments and even volatile assets like cryptos, central banks are once again seeing the need to get creative.

–With the help of Alastair Marsh.

More stories like this are available at bloomberg.com

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