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WOLF & CO Insights Money & Payments: The Potentialities of a Central Bank Digital Currency (CBDC)

Money & Payments: The Potentialities of a Central Bank Digital Currency (CBDC)



The United States (U.S.) payment system comprises financial institutions, businesses, and households, and moving funds across these players relies on an interbank payment service. For the U.S. economy and financial system to be stable and fully functional, it relies on this interbank payment system. Therefore, it is imperative to constantly improve the U.S. payment system to make payments convenient, accessible for all, faster, and cheaper. To this end, recent technological improvements have been key to the progress witnessed in the U.S. payment system. For example, the Real Time Payments (RTP) network developed by The Clearing House has been a major milestone for real-time interbank payments, especially for lower value payments. Presently, there is an ongoing debate on the role of cryptocurrencies in the U.S. economy. Stakeholders are questioning the pros and cons of introducing a central bank digital currency (CBDC), and its potential impact on domestic payment systems.

The Potential of a U.S. CBDC

Despite the current payment system in the U.S. being generally effective and efficient, numerous issues are plaguing the financial system. At least 7 million U.S. households – over 5% of all U.S. households – are unbanked. Technology advancement and other initiatives by the public and private sector are aimed at improving financial inclusion for all in the economy. A CBDC has been hailed to be a bridge between conventional and new payment services. Introducing a CBDC will allow U.S. households to use digital money known to have no credit and liquidity risk. Eventually, this lays a safe foundation necessary to spur private-sector innovations targeting payment services.

Introducing a U.S. CBDC is central to reducing barriers of entry for small firms targeting payment service innovation. Initially, small-size firms encountered huge costs and risks hindering their ability to participate in the innovation of private money. Additionally, speed and efficiency are increasingly becoming a demand in the digital economy. It is possible to achieve all this using a CBDC because it is a form of digital money programmed to deliver at certain times or even in real-time.

A U.S.-issued CBDC will be pivotal to preserving the key role played by the U.S. dollar in international trade. As a world reserve currency, support from a CBDC will grant increased stability and momentum for global dominance. If rolled out early enough it will benefit the U.S. domestic businesses, households, and government through lower borrowing costs.

Further, cryptocurrencies just like the U.S.-issued CBDC seek to advance financial inclusion for all in society. Realizing this objective requires lowering the cost of transactions, especially for lower-income households. This is possible using a CBDC, and is only one among other potential use-cases targeting vulnerable households in the U.S.

Drawbacks of a CBDC in the U.S. Economy

A CBDC in the U.S. financial system would alter the structure of the financial sector. For instance, implementing an interest-bearing CBDC would result in reducing the overall amount of deposits further leading to a decline in credit available to businesses and households. This low number of deposits available in the banking system will be costly due to increased bank funding expenses. Similarly, the U.S.-issued CBDC will mean investors shift from other low-risk assets such as treasury bills, leading to high credit costs and few options of credit instruments for the government and businesses.

CBDCs would be more attractive to risk-averse users, which is akin to destabilizing the financial system. This is especially relevant when considering the quick ability to convert other forms of money to the U.S.-issued CBDC especially during times of economic stress.

Introducing a CBDC leads to additional challenges, such as establishing an appropriate balance between protecting consumer privacy and ensuring all transactions are transparent to avoid financing criminal activities. This balance is often difficult to attain in the cryptocurrency ecosystem.

Finally, just like the current payment services, a CBDC infrastructure is vulnerable to cybersecurity risks and other operational disruptions. Even with the available technology, it is still difficult to put necessary defenses in place due to the numerous entry points available for bad actors within a CBDC network.