Central Bank Digital Currency (CBDC) are digital form of paper currency that are legal tenders issued and backed by the central banks. They are unlike the cryptocurrency; however, they are based on the blockchain technology.
The increasing interest of the central banks with CBDC is reflected in the efforts put by about 110 countries to explore CBDC at one level or another. China (e-CNY) and Bahamas (Sand Dollar) have already started transacting with CBDC.
The primacy of the U.S. dollar grants the U.S. government and economy special privileges, including
- Ability to print money with relative freedom
- Issue debt at low interest rates reducing the cost of capital both for the government and U.S. firms
- Maintain long-term and persistent trade surpluses with other economies
- Monitor global transactions—and therefore apply economic sanctions to countries and individuals without much effort or harm to self
However, unless the U.S. policymakers take decisive steps to adapt to an increasingly digital financial system, the United States risks losing the economic and geopolitical advantages afforded to it by the dollar’s dominance of the global financial system. Moreover, the weaponisation of Dollar has reduced the interest that countries have in using dollar as the means of trade.
Challenges presented to US Dollar dominance by CBDC are:
- CBDC can be used as an effective medium for international payments in bilateral trade, replacing the advantage that dollar enjoys.
- CBDC can remove the need for transaction fee which is required to be paid with every transaction done in dollar and forms a hefty sum over time.
- CBDC can promote financial inclusion and make more people involved in international trade, because of ease of currency exchange.
- The effectiveness of economic sanctions through weaponization of Dollar, which USA used to influence the political and economic governance of other countries, will reduce.
However, the challenges have not uprooted the dollar system yet. There are challenges to the mass adoption of digital currencies. To play an effective role as stores of value and medium of exchanges, currencies need to have the trust of their holders and users. Volatility, cyber theft, and the usage of private digital currencies for illegal activities currently limit trust and adoption. However, simplicity of use, especially like the interoperable BharatQR will speed up the adoption of the digital currency.