How Central Bank Digital Currencies may impact the monetary system?

4 Mar 2022 , 10:55 AM

The contemporary digitalization of the economy has brought a paradigm shift to the way people make payments. With this shift coupled with the pandemic, the usage of cash (the only medium of central bank money available to the public) has fallen significantly. The situation has prioritized the demand for digital currencies and, therefore, central banks can no longer afford to ignore it. Hence, Central Bank Digital Currencies (CBDC) would undoubtedly become an integral part of the future economies and shall herald a new era.

What is CBDC?
These CBDCs are a form of digital money, denominated in the national unit and accounts to the direct liability of the Central Bank. These digital currencies that use blockchain technology are directly created and offered by the central banks, unlike other speculative cryptocurrencies and tokens. They are typically backed by similar ways to cash, i.e., by gold or SDR reserves, thereby achieving consumer trust and ensuring all-round protection and transparency. Moreover, CBDCs offer lower costs, liquidity, integrity, and fast settlement in financial transactions and also have a huge impact on the country’s monetary system and its stakeholders.

Here’s how Central Bank Digital Currencies impact the major stakeholders of the monetary system.
Besides impacting the monetary system in India, CBDC hugely impacts the international monetary system. The major stakeholders comprising retail customers, banks (domestic, international & central), fintech companies, and financial network players are also equally affected by CBDC. Therefore, for embarking on CBDCs, one needs to consider the varying levels of impact it has on the major stakeholder groups.

Impact on Retail Customers
CBDC offers them risk-free payment options, unlike volatile cryptocurrencies. It holds the potential to foster payments much faster and cheaper in a safe and hassle-free way. 

Impact on Corporate Customers
CBDC reduces the cost, time, and risks involved in international payments. It also simplifies their account books and facilitates financial compliances.

Impact on Banks
Domestic banks shall be adversely impacted by CBDCs as Central Bank itself will act as deposit-taker. In this case, there is a drastic reduction of the available resources of the domestic banks that also reduces their ability to provide credit.

CBDC can transform international banks in areas like international and cross-currency trade. They are required to re-invent their role in cross-body transactions in a CBDC-driven economy.

Central Banks also need to change their operation mode by reducing the cost of printing, transportation, etc. Moreover, they should identify illicit transactions with the help of the inbuilt audit trail in CBDC.

Impact on Fintech & Financial Network Players
CBDC will be a bonanza for financial network players and technology companies, as they can devise innovative software to meet new standards of domestic and international transactions. These players must ensure that they have the required skills, capabilities and technology to provide new platforms with a tune to the digital era.

Besides, CBDC impacts the existing monetary systems like Commodity Money that is made up of precious metals or commodities, including gold and silver coins, having intrinsic value. It also affects commodity-based money that involves certificates with no financial value but can be exchanged with precious metals like Gold and Silver.

Summing up
Although the shift to CBDC can be daunting as it requires the right preparation and partnerships, it adequately supports the monetary system and the evolution of our society. After all, CBDCs bring much-needed transparency, trust, and confidence to the table over the traditional existing paper notes and metal coins.

The author of this article is Vidit Garg, Director at MyGoldKart
The views and opinions expressed are not of IIFL Capital Services, indiainfoline.com