As cryptocurrencies like Bitcoin have become more popular, central banks around the world have been working to create their own digital currencies.
Only two countries have officially launched fiat digital currencies. The Bahamas became first in 2020, followed by China, which began issuing its digital yuan about three months ago.
Other countries where studies are ongoing are Indonesia, Norway, Japan, Sweden and South Korea. In Africa, Egypt, South Africa, Morocco and Kenya are studying the feasibility of the technology.
Nigeria and Ghana plan to test an official digital currency (e-naira and e-cedi, respectively) later this year.
What are CBDCs and how do they work?
A central bank digital currency (CBDC) is a country’s official currency in digital form. Instead of paper money, Apex Bank issues government-backed electronic coins and bills.
CBDCs are similar to existing cryptocurrencies (like Bitcoin, Ethereum, etc.) in the sense that both are transmitted electronically and are blockchain-based. Blockchain is a type of distributed ledger technology.
However, one of the key differences is that while cryptocurrencies are designed to be decentralized (i.e. unregulated), fiat digital currencies are deployed on centralized and private blockchain networks overseen by a central bank.
The fiat digital currency is issued by banking regulators to banks, which in turn make it available to their customers. Each bank will be connected to the government-run blockchain system. The system allows banks to aggregate transaction data, which is forwarded to the central bank.
Whether traditional bank accounts will work for a digital naira, for example, is unknown. Users may need to open special accounts similar to the mobile wallets currently used for cryptocurrencies that allow for seamless transactions.
There is also a difference in currency value and volatility. For example, an e-naira is pegged to the paper naira at ₦1 : ₦1. Compared to the extreme volatility associated with cryptocurrencies, CBDCs are relatively stable. When their values are tied together, a digital currency will fall and rise in line with general fluctuations in the value of the local currency.
On paper, the transition to digital currency is an exciting prospect and should help reduce cash dominance, but it will not be easy, especially in African countries. This is due to the same challenges that have slowed the full adoption of digital technologies.
In Nigeria, for example, smartphone penetration remains low, estimated at less than 20% of the population in 2019, compared to nearly 60% in China, according to a Newzoo report.
The CBN and banks need to consider feature phone users and make digital naira transactions accessible via USSD codes, which would also help advance financial inclusion goals.
There are also cyber security risks to consider as well as internet penetration.
Meanwhile, it remains to be seen whether regulators will attempt to phase out cryptos entirely as China has done as digital currencies are rolled out.
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