Central Bank digital currencies raise privacy concerns

Central Bank Digital Currencies could reduce the role of commercial banks as intermediaries in the financial system. PHOTO / MICHAEL KAKUMIRIZI

What you need to know:

Central Bank Digital Currencies risk killing commercial banks since customers could convert their deposits to virtual currency, leading to bank runs.

The advent of cryptocurrencies, led by the groundbreaking Bitcoin, has fundamentally transformed the financial landscape, challenging traditional notions of currency, transactions, and financial intermediaries. 

As the world continues to grapple with the implications of decentralised digital currencies, a new player has entered the scene: Central Bank Digital Currencies (CBDCs). But will CBDCs change the financial landscape in the future?

Cryptocurrencies, such as Bitcoin and Ethereum, have disrupted traditional financial systems by introducing decentralised and borderless transactions. 

Built on blockchain technology, these digital currencies operate on a peer-to-peer network, eliminating the need for intermediaries like banks and payment processors. The decentralised nature of cryptocurrencies enhances security, transparency, and financial inclusion, empowering individuals globally to participate in the economy with increased autonomy.

However, the volatility and regulatory uncertainties surrounding cryptocurrencies have prompted central banks worldwide to explore the potential of CBDCs.

Recently, the founders of a Safemoon were charged by the Securitie Exchange Commission SEC in the USA with securities fraud and unregistered offering of crypto securities. 

However, there have been positive strides in the industry with a ground breaking partial win in favour of Ripple, the issuing company of a popular cryptocurrency known as XRP where it was ruled that issuance of XRP to the public did not amount to securities sales. 

What are CBDCs? 
Unlike decentralised cryptocurrencies, CBDCs are digital currencies issued by central banks, making them a government-backed form of digital currency.

The emergence of CBDCs raises the prospect of combining the benefits of digital currencies with the stability and regulatory oversight provided by traditional financial institutions.

Paradigm shift in monetary policy
Central Bank Digital Currencies represent a significant evolution in monetary policy.

Unlike cryptocurrencies, CBDCs are controlled and regulated by central authorities, allowing for greater control over money supply and the ability to implement monetary policies effectively. This level of control offers central banks the means to address economic challenges, such as inflation and deflation, with more precision.

One of the key advantages of CBDCs is the potential to reduce the reliance on physical cash, offering a more efficient and secure method of conducting transactions. 

Digital currencies issued by central banks could streamline payment systems, reduce transaction costs, and enhance the speed of cross-border payments, benefiting consumers and businesses alike.

Financial inclusion and accessibility
CBDCs have the potential to address issues of financial inclusion by providing access to formal financial services for the unbanked and underbanked populations.

Digital currencies issued by central banks can be more easily integrated into existing financial systems, creating an inclusive environment where individuals without traditional banking access can participate in the digital economy.

Furthermore, CBDCs can serve as a catalyst for innovation in the financial sector. Smart contracts, programmable agreements that automatically execute and enforce terms, could be integrated into CBDC platforms, fostering the development of decentralised finance (DeFi) applications and services.

Privacy concerns, cybersecurity risks, and the need for robust regulatory frameworks are among the key considerations as central banks navigate the path towards implementing CBDCs. 

Striking a balance between innovation and regulatory oversight will be crucial to ensuring the stability and integrity of the financial system.

While the potential benefits of CBDCs are significant, challenges and considerations must be addressed. 
Some of these criticisms include:

CBDCs, being digital currencies, raise concerns about user privacy. Unlike physical cash transactions, which are relatively private, digital transactions can be tracked more easily. Critics worry that the extensive data collection associated with CBDCs could compromise user privacy.

Surveillance and control
The centralised nature of CBDCs allows central banks to monitor and control transactions. Some critics argue that this level of surveillance could be abused, leading to a loss of financial freedom and potentially enabling government overreach.

Financial stability and Bank runs
Introducing CBDCs might lead to a significant shift of funds from commercial banks to central bank accounts. If depositors perceive CBDCs as safer, traditional banks could face liquidity challenges, potentially leading to bank runs and impacting overall financial stability.

Disruption to commercial banks
The widespread adoption of CBDCs could reduce the role of commercial banks as intermediaries in the financial system. This could affect their profitability and disrupt the traditional banking model.

Implementing CBDCs involves complex technological infrastructures. Concerns about potential system failures, cyber-attacks, or technical glitches could undermine confidence in the stability of CBDCs.

As central banks globally explore and experiment with CBDCs, the coming years will likely witness a dynamic interplay between traditional financial institutions, decentralised cryptocurrencies, and this new breed of government-backed digital currencies. The future of finance is being shaped by the convergence of digital innovation and regulatory pragmatism.

Norbert Kiiza Barigyeis education partner, EGM Securities Limited.