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Preparing for Central Banks Digital Currencies

November 18, 2020 By Mircea Vasiu

An increasing number of central banks have announced intentions to introduce the so-called Central Banks Digital Currencies (CBDC)

The pack is led by a surprising central bank – none other than the European Central Bank (ECB).

Why surprising? Because the ECB (and Europe in general) is known for reacting slower when compared to, for instance, the United States. To give you an idea, during the 2008-2009 Great Financial Crisis, the Fed in the United States slashed the federal fund rate to zero. Later, it innovated via quantitative easing.

ECB did the opposite. It hiked the key interest rate in the middle of the crisis. To this day, it remains in history as one of the central banks’ decisions that did not make any sense. The ECB quickly reversed it, but the damage was done. Also, it proves the point that the ECB is slower to react.

Not this time. The ECB leads by announcing the filling for the “digital Euro” trademark.

How to manage a retail CBDC?

Following the ECB’s declared interest, other central banks began dedicating resources to CBDCs and their implications. For the retail trader, some important aspects need to be clarified.

Despite the name, a CBDC is not a cryptocurrency. Instead, it acts as the extension of the fiat currency into the digital space. The so-called retail CBDC will be accessible to financial institutions and the public. It will have a general-purpose, backed by the full faith of the central bank. In sharp contrast, we cannot say the same about the current cryptocurrencies in the digital space.

For a currency, safety and transparency are crucial aspects. No central bank in the world would think of going digital if there is even the slightest chance for the currency to be pirated. Now that blockchain technology exists, security issues seem to have found their solution.

One important question for CBDC fans. Will such a currency compete with the banking sector? Also, what is the interest rate that applies to a retail CBDC? Moreover, will the same monetary policy framework apply to a CBDC and to a regular currency?

It becomes evident that there are more unanswered questions than solutions at this point in time. However, this is how change takes shape. At first, there is an idea. Next, the idea is backed by research. Research, on its own, leads to other developments.

One thing is for sure – the world’s financial system will undergo a change. Digital assets are here to stay, and central banks are in a hurry to implement similar concepts as soon as possible.