Cryptocurrencies and CBDCs: Transforming Financial Transactions in the Digital Age

Written by Salomi Michail
21 June, 2023

Global adoption of cryptocurrencies

Digital currencies like bitcoin are gaining increasing popularity worldwide. According to Phillips (2020), bitcoin ranks as the sixth largest currency globally, with the US dollar holding the position as the largest traditional currency. While cryptocurrencies such as bitcoin, ether, ripple, litecoin, and tether continue to enjoy popularity, their rates of adoption vary across different regions of the world. In developing countries, where high inflation rates and economic uncertainty are prevalent, cryptocurrencies offer a viable alternative to safeguard consumers against fluctuating inflation and economic instability. Moreover, the adoption of cryptocurrencies in these nations has the potential to foster economic growth and enhance financial inclusion among the unbanked population.

The number of available cryptocurrencies has grown rapidly since 2010. As of today, there are 25,720 cryptocurrencies that exist globally with a market capitalization of US$1 trillion.

Bitcoin (BTC) remains the most popular and widely recognized cryptocurrency. It was the first cryptocurrency to be created and has the largest market capitalization among all cryptocurrencies.

Bitcoin as method of payment

Bitcoin transactions offer transparency as all parties involved can view and trace payments. Additionally, a comprehensive transaction history is permanently stored in the Bitcoin network, ensuring accountability. The unalterable nature of the blockchain prevents counterfeiting and adds another layer of security to the system. Unlike traditional fiat currencies, Bitcoin is not subject to government monetary policies, making it less susceptible to inflationary pressures. Supporters argue that the limited supply (in circulation there are only 21 million bitcoins) and decentralized nature of Bitcoin protect its value. Moreover, companies often prefer Bitcoin over credit cards due to lower transaction fees, simplified international payments, and decreased fraud risks.

Criticisms of Bitcoin

Despite the advantages for users, some critics have raised issues about the currency

  • Using bitcoin as a medium of exchange can be challenging since only a limited number of countries recognize it as a legally accepted form of currency. As a result, its widespread use in transactions may encounter obstacles.
  • Bitcoin is also non-refundable, rendering its value extremely volatile and despite the boom currency in 2017, it is an unreliable method of storing value.  Tesla for instance, includes bitcoins on the balance sheet, which on one hand could provide transparency to investors about its risk management strategies. On the other hand, risk averse investors might not invest in Tesla due to volatility, lack of regulation and maturity in the market, unpredictability of bitcoins and the price being affected by market manipulation or other external factors.
  • Bitcoin’s rise to popularity is also linked to the trading of illicit goods on the dark web and on platforms such as Silk Road, which is an online portal used to trade in illegal goods until it was shut down in 2013.This led to many politicians and government officials criticizing the Bitcoin platform as being a tool for criminals with no real value as a currency.
  • The mining process of cryptocurrencies demands a substantial amount of computing power and electricity. However, finding a sustainable solution to meet the energy needs of cryptocurrency mining remains a challenge for the industry.

Fiat currency versus bitcoin

In June 2021, El Salvador was the first country to officially adopt bitcoin as a recognized form of currency exchange. The government introduced a new digital wallet for its citizens and installed over 200 cash machines to facilitate bitcoin transactions. The adoption of bitcoin was presented as a means to enhance economic prosperity and generate employment opportunities. However, the reception to this move varied within the country, with differing opinions about its potential benefits for economic growth. Shortly after implementation, some business owners in the area known as Bitcoin Beach reverted to conducting transactions in cash. The decision was influenced by the volatility of bitcoin’s value, which resulted in financial losses for them.

Why is still cash used?

  • Many consumers have the feeling that they control their money better when they have cash on them and as a result they spend less.  
  • For the group of people like the elderly, digitalisation is not easy to follow as they face difficulties with technology, letting go of the traditional ways and conforming to the new status quo.
  • Cash provides a form of security, independence and power.
  • Cash is the most liquid asset because it’s readily available to use and is vital for the going concern of a Company. It offers flexibility in times of crisis i.e. during Covid-19 where a lot of businesses could go bankrupt but survived due to availability of cash.
  • By making the transactions in cash the risk of possible fraudulent activities that could take place online through the payment systems is avoided.

Central bank digital currencies (CBDCs)

According to data from the World Bank, over 1.7 billion individuals globally do not have access to traditional banking services. However, the majority of commercial transactions today rely on digital technologies, with only a small portion, around 3%, involving physical cash. As a result, relying solely on cash transactions puts this population at a considerable disadvantage.

The promise of CBDC designs is to make digital currencies available to every individual regardless of his or her ability to open a bank account.

A Central Bank Digital Currency (CBDC) refers to a digital representation of a nation’s official currency, issued by the central bank. It serves as an innovative form of currency that individuals and institutions can utilize for payment settlements, eliminating the necessity of physical cash transfers. The global trend showcases a gradual decline in cash usage, alongside the widespread growth of digital payment methods. The introduction of digital currencies by central banks presents an opportunity to further expand the realm of digital payments, now within the realm of officially recognized government-backed currencies. They are issued by central banks, whose role is to support financial services for a nation’s government and its commercial-banking system, set monetary policy and issue currency. Unlike cryptocurrencies, which are decentralized, CBDCs are state issued and operated.

Globally, banks and financial institutions process far more transactions digitally than they do in physical branches.

There are two forms of CBDCs: wholesale and retail or general purpose. Wholesale variants would keep access to a certain group of users such as commercial banks and other large financial institutions. On the other hand, a general purpose CBDC would be widely accessible for everyday users to obtain.  The Bank for International Settlements (BIS) operates as a bank for central banks. It does not have accounts for individuals or governments but serves central banks of the countries that are members with BIS.

At present, 87 countries-representing more than 90 percent of global GDP are exploring CBDCs.

In October 2021, Nigeria was the first African country to introduce its digital currency, known as eNaira. Users have multiple access points to the currency, including a mobile app, online banking, and mobile phone calls. The Central Bank of Nigeria (CBN) ensures the protection and anonymity of user data while actively monitoring transactions to prevent illicit activities. The Nigerian government has high expectations for the CBDC’s impact, projecting a potential increase of US$29 billion in the country’s GDP over the next decade. The eNaira serves various purposes, such as facilitating retail purchases, transferring funds to and from bank accounts, and enabling money transfers to linked bank accounts.

Reasons for Central Banks turning to CBDCs and relevant benefits and concerns

  • Cash usage declined and this forced central banks to reexamine their role in the monetary system.
  • Growing interest in privately issued digital assets.  The European Central Bank states that as many as 10% of households in six large EU countries own digital assets.

Relevant benefits

  • Convertible, convenient accepted and available and low cost
  • The system is secure, resilient, scalable and flexible
  • Reduced costs: shifting from physical infrastructure to digital finance reduces direct costs (reduced compliance costs for banks)
  • Electronic payment systems speed and efficiency is improved
  • Greater access for those without bank accounts since CBDCs are accessible through mobile devices
  • Mitigates risk of fraud and enhances security of payment ensuring the transaction is finalized and unalterable through private-key cryptography

Potential concerns

  • Digital money means when money becomes digital, it also becomes traceable and therefore taxable
  • Technology – some countries might not be advanced in terms of technology and face technological issues
  • May take time and effort for the infrastructure to be developed properly

In summary, the development of cryptocurrencies and the introduction of CBDCs represent the shifting dynamics in financial transactions. As our society becomes increasingly digital, it is essential to strike a balance between fostering innovation, implementing effective regulations, and addressing any potential obstacles. This balance is vital for the seamless integration of digital currencies into the mainstream economy.

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