The rise of central bank digital currencies

The Reserve Bank of Australia is running a pilot to explore retail use cases for a central bank digital currency (CBDC) — a digital Aussie dollar or e-dollar, which could be held digitally like cryptocurrencies. This is not the first time CBDC is being tested for real-world use by the RBA. It has carried out two pilots in the last two years to test tokenised CBDC for the wholesale market and cross-border payments.

What is CBDC?

According to RBA, a CBDC is like a digital form of cash and has legal tender status, which makes it widely accepted. The idea of CBDC comes from cryptocurrencies like Bitcoin, but compared to unbacked crypto assets, which are inherently volatile, CBDC is a centralised fiat. Which means customers and businesses can use it to make electronic payments without involving financial institutions, such as banks.


CBDC gains traction amid crypto crash

Cryptocurrencies' meteoric rise and subsequent crash has created an urgent need for regulating the sector. The conversation has shifted to the development of a state-run digital currency as central banks fear losing control over the money supply and payments system.

Although cryptocurrency prices have clawed back some ground, the crypto winter is far from over. The recent crypto market crash driven by the de-pegging of TerraUSD and compounded by overleveraged financial institutions has triggered increased scrutiny of the $150-billion stablecoin market¹. The current meltdown of TerraUSD may be the final push central bankers need to consider issuing their digital currency.

In theory, stablecoins are not speculative investments; they're supposed to bridge the traditional and crypto worlds. They are typically backed by real-world assets, like the US dollar, and are considered less volatile than a conventional cryptocurrency.

But after the collapse of TerraUSD, many algorithmic stablecoins have lost their dollar peg. This includes Tether, the largest stablecoin, which briefly broke its $1 peg in May amid panic in the crypto market. As a crackdown looms on not-so-stable stablecoins, the sector could see tough rules and aggressive monitoring.


The race for digital currency

Globally many governments are exploring CBDCs as they grapple with cryptocurrency's explosive growth. According to the IMF, around 100 countries, including Singapore, Korea, Australia, Sweden, Norway, Russia, and India, are developing their digital currencies, with the European Union planning to introduce a digital euro bill in 2023.

The Bahamas' Sand Dollar was the first CBDC to launch in 2020, followed by Jamaica and Nigeria. But the only major economy to pilot a digital currency at a large scale is China, which began e-CNY trials at the end of 2021. As it continues to crack down on cryptocurrencies, Beijing is expanding the use of digital Yuan for loans and financial products. More than a hundred million people use e-CNY in more than 20 cities.

There are several reasons CBDCs are becoming popular, including developing secure and efficient payments and promoting financial inclusion. Nevertheless, adoption is closely linked to regulation of the rapid growth of cryptocurrencies.

Although CBDCs could benefit consumers by enabling faster and cheaper payments, they also pose significant privacy risks— it isn't as anonymous as cash. A central bank's digital currency can provide governments with considerable access to citizen data, leading to concerns that it may curtail civil liberties.

The success of CBDC will depend on how it addresses this issue.