This past year has seen many surprises for those who work in the digital asset space. Unexpected downfalls, anticipated tech updates and most notably, increasing interest from governments and central banks in Central Bank Digital Currencies (CBDC), a move that speaks to an evolving regulatory landscape worldwide.

With so much happening all at once, this was a landmark year, showing us how blockchain technology is revolutionizing both finance and society as we know it.

What are CBDCs?

Cryptocurrencies and CBDCs are two separate financial worlds. A CBDC is an extension of existing traditional money, allowing everyone from consumers to enterprises access to an electronic form of national money. As the name suggests, it is issued and regulated by centralized banks and pegged to a country’s fiat currency.

Cryptocurrencies on the other hand are governed by decentralized ledgers and are largely value-dependent based on a free market. They operate on a peer-to-peer network, allowing users to send payments directly without having to go through third parties like banks or financial institutions.

Partly, the volatility of crypto markets has led to the rise of CBDCs, which is luring people to a centralized digital currency that has a familiar face but a completely different nature. 

What developments have CBDCs seen so far?

It's clear that CBDCs are top of mind for many countries around the world. According to the Bank for International Settlement (BIS), at least 28 CBDC pilot initiatives have been put in motion, with three already released. Another 68 central banks are exploring their own possibilities.

The PwC CBDC Global Index 2022 reveals that more than 80% of central banks are considering the launch of a CBDC or have already done so, either for retail or wholesale payments.

To name a few, CBDCs are now in use in the Bahamas and Nigeria, with Jamaica and the Eastern Caribbean expected to follow.

The People’s Bank of China began its journey towards a digital yuan in 2014 and is currently conducting large-scale public trials in select cities. The e-CNY was one of only three payment methods accepted at the venue during the 2022 Winter Olympics.

In February this year, the Reserve Bank of India announced its plans for a digital rupee, which is being tested for retail transactions in Mumbai, New Delhi, Bengaluru, and Bhubaneswar.

The central banks of France and Luxembourg have also used an experimental CBDC to settle 100 million euros worth of bonds.

Such a global movement towards government-led digital currency is driven by ambitions across scalability, cross-border payments, crime prevention and financial inclusion—elements which will considerably shape our future economic landscape.

The emergence of cryptocurrency and CBDCs has been a major development in the world of finance. While some may view them as competitors, there is a growing body of evidence that suggests they can be complementary and work together to create an efficient global financial system. Given their different natures, it may seem counterintuitive to consider how cryptocurrencies and CBDCs could co-exist in harmony within a single financial system, but there are several possible scenarios where this could work out well for both sides.

A hybrid financial system whereby both currencies are accepted side by side

This would allow for both currencies to retain their own unique characteristics while facilitating transactions between users who prefer one over the other.

A dual-currency environment whereby individuals keep both types of money in their wallets

This way, individuals will enjoy more freedom when it comes to spending their funds since they could use either currency depending on their needs at any given time, without having to exchange one for the other beforehand.

A marketplace where users can convert cryptocurrency into CBDCs

This would give users access to more liquid markets where they could buy or sell assets using whichever currency is the most suitable at any given moment, while interacting with counterparties who accept either type of money. 

The road ahead

There are various ways in which cryptocurrency and CBDCs could co-exist peacefully within a single financial system. However, much still needs to be done before such an arrangement becomes reality—number one being the regulatory concerns among certain countries’ monetary authorities who may be hesitant to grant legal status to cryptocurrencies amidst fears that they could threaten economic stability through increased volatility and fraud.

The secondary concern would be the lack of decentralization this would give users. Centralized management of users’ funds at the government level is not always everyone’s cup of tea. We cannot guarantee that governments won't enforce rules regarding how to spend CBDCs or impose withdrawal limits.

Nonetheless, progress around CBDCs is continuing as evidenced by initiatives such as Facebook’s Libra project, which seeks to create an open network for people around the world using a Stablecoin pegged 1:1 against multiple national currencies, including US Dollars and Euros. Such developments indicate that collaboration between traditional systems and new technologies can indeed occur if properly managed.

Although our current understanding of how cryptocurrency and CBDCs might co-exist remains incomplete, mostly due to regulatory uncertainty surrounding them, there is great potential for both technologies if implemented correctly. Going forward, the key will be striking a balance between providing enough protection from risk while maintaining enough freedom for innovation, so that all stakeholders benefit from any arrangement that is ultimately adopted.