Are CBDCs the solution?

As Bitcoin climbs slowly, U.S. banks face tough times and several stablecoins are faltering.

As Bitcoin climbs slowly, U.S. banks are struggling and several stablecoins are stuttering. The question, then, is whether the current financial system should be modernized. But what are the policy implications of CBDCs? And is the digital euro coming to Europe?

Digital money - what's new?

Digital money isn't just digital money. While fiat money is issued by commercial banks, the digital euro would be a kind of third form of central bank digital currencies (CBDCs) - alongside cash and bank deposits. Like cash, it would be put into circulation directly by the central bank.

In contrast, cryptocurrencies with a stable price—so-called stablecoins—are issued by private companies. Recent trust losses in BUSD and USDC may have strengthened CBDC supporters' view that crypto investors are exposed to the excessive issuer risk of unregulated private firms.

Shaping the future or enforcing control?

But are CBDCs the solution to everything? Crypto enthusiasts often link 'legitimate coded money' less with illicit transactions and more with the loss of privacy. People often point to authoritarian countries like China, where CBDCs are used to monitor citizens and businesses:

In March the integration, the "superapp" WeChat integrated the digital yuan alongside WeChatPay as an additional payment method. In December 2022, Alipay had already announced the integration of the renminbi acceptance network. WeChat has more than 1.3 billion users.

Florida, by contrast, is seen as crypto-friendly: with the banking crisis in the U.S., the governor on March 20 signaled support for banning U.S. central-bank money.

Ultimately, the political sentiment of each government will play a decisive role in what purpose central-bank money should serve.

And what's the EU's stance on CBDCs?

In December 2022, EU member states reached agreement on a common set of rules for an EU digital wallet. They commit to making a wallet solution available to citizens. For citizens themselves, use remains voluntary.

In a kind of in-app wallet, users could digitally process a range of requests, from birth certificates to mobile licenses. EU states hope this marks the start of uniform digital data traffic across the European internal market.

The ECB plans to vote this fall on introducing the digital euro as a complement to cash. A well-designed digital euro as part of the EU wallet isn’t far-fetched. Despite the criticism, the EU seems set to push ahead with the overall CBDC plan.

Conclusion: Are CBDCs the start of a new financial order?

Rolling out CBDCs for the public would have wide geopolitical and financial implications. It's still unclear which model the ECB will choose upon rollout, and what role the central bank, commercial banks, and external financial service providers will play.

Moreover, it's unpredictable how consumers will request the digital euro during the rollout. Too high demand could destabilize the ECB's currently controlled monetary policy and trigger a surge in interest rates.

Given recent failures like Silicon Valley Bank in the U.S. and rescue efforts around Switzerland's Credit Suisse, it's a risky undertaking right now.

On the other hand, CBDCs could boost financial inclusion and automate bureaucratic payment processes. An alternative to CBDCs for individuals could be modernizing the so-called wholesale CBDCs (interbank settlements).

This less revolutionary approach could, on one hand, speed up widespread crypto adoption and, on the other hand, raise governments' push for tougher regulations.