Central Bank Digital Currency: The Future Of Your Money

Digital currency is any currency that’s available exclusively in electronic form. Electronic versions of currency already dominate most countries’ financial systems. What differentiates digital currency from the electronic currency that’s already in the bank accounts of everyday Australians is that digital currency never takes physical form.

You can go to an ATM right now and transform the electronic record of your currency holdings into physical dollars. Digital currency, however, exists entirely in the digital realm, never leaves a computer network, and is exchanged exclusively online.

There is one main differentiator between different types of digital currencies: the level of centralisation of the currency. Digital currencies like bitcoin and Ethereum are decentralised and exist on blockchains that are run by tens of thousands of entities distributed across the world. These entities work to verify each transaction before cross-referencing with the rest of the entities in the system, ensuring everyone has the same record and that the new transactions are legitimate in accordance with the prior payment history.

Decentralisation like this ensures that no single entity can take control of the transactions or the digital currency, which greatly reduces any risk of foul play.

On the flip side, some digital currencies are entirely centralised, meaning they are controlled by a singular entity. This entity has complete control of all aspects of the currency and has the ability to manipulate the currency and the payment history. This entity can add or remove money from accounts, change the number of coins available, block payments, alter old transactions and more. You can see how this could cause problems in some situations.

Blockchain technology, which provides the foundation for cryptocurrency, is the most common form of distributed ledger used by digital currencies. According to CoinMarketCap, there are more than 2.4 million cryptocurrencies available.

A central bank digital currency (CBDC) is a centralised digital currency that is issued and overseen by a country’s central bank. Think of it like bitcoin, but if bitcoin were managed by the Reserve Bank of Australia (RBA) and had the full backing of the Australian government.

According to the IMF, more than 100 countries are exploring CBDCs at one level or another. The Reserve Bank of Australia (RBA) is in the pilot phase of a CBDC for Australia in partnership with local banks, and in August 2023 released an update that suggested the creation of a CBDC in Australia is still “some years away”.

CBDC is already available in the Central Bank of The Bahamas (Sand Dollar), the Eastern Caribbean Central Bank (DCash), the Central Bank of Nigeria (e-Naira),the Bank of Jamaica (JamDex) and the digital Yuan in China, to name just a few.

The US Federal Reserve issued a report in 2022 that “a CBDC could fundamentally change the structure of the US financial system”. Subsequent analyses have highlighted both potential benefits and significant risks, particularly in terms of privacy and financial autonomy.

As the US dollar is the world reserve currency, it could also fundamentally change the structure of the global financial system, which could impact Australia. For Australians, this potential global shift underscores the need for careful consideration of how a CBDC might affect our financial sovereignty and the privacy of our transactions.

While discussions about CBDCs are ongoing globally, the implementation of a CBDC in Australia remains a complex and debated topic.

A CBDC would be a government-backed digital currency pegged to the Australian dollar with a one-to-one conversion rate. It would be considered legal tender, unlike decentralised digital currencies in Australia.

Currently, legislation around digital currencies does not specifically cover CBDCs. If a “digital Australian dollar” was rolled out, there is the question of whether it would constitute a counterfeit currency. If it is an imitation of the Australian dollar that can be created at will, then there is a case that it could be.

The way a CBDC may work in Australia is yet unknown, but if you consider the differences between a CBDC and the current Australian financial system, you may not like the extra powers that it provides the entity in control.

As mentioned previously, CBDCs are centralised currencies, meaning that one entity, usually the central bank and government, controls all aspects of it. This means the government and central bank have access to all transaction records, the ability to alter the transaction history at any time, manipulate the currency’s supply and offer increased surveillance over the population’s financial activity.

This is the precise reason why decentralised currencies like bitcoin and Ethereum were created. To remove the power from a single entity and spread it among anyone, meaning that no single party gets to control the system.

This is a major point of contention for CBDCs and is a legitimate concern for everyday Australians who just want to be able to access their money when they need it. Given Australia’s existing advanced financial infrastructure, the benefits of a CBDC for the average citizen are not immediately clear.

On the other side of the coin, an advantage of a CBDC when compared with decentralised currencies, is that it is more likely to be deemed legal tender in Australia. That means all economic actors must accept it for any legal purposes. You can pay your taxes with it, and businesses must legally accept it for repayment.

This contrasts with decentralised digital currencies, like bitcoin and Ethereum, which are not currently legal tender in Australia.  Luckily, there are many solutions that make spending cryptocurrencies easy, like crypto debit and credit cards or crypto-to-fiat services.

When you use crypto as a form of payment, you may also create a taxable event, which means you may owe capital gains taxes each time you purchase something with bitcoin or Ethereum, as they are treated as property in Australia. This is in addition to any sales taxes. With CBDC, you would only owe any applicable sales tax, just like using a physical currency.

As CBDCs are digital and, therefore, programmable, the central bank in control may implement a taxation system that occurs at the payment level. This means you would pay any applicable tax on every transaction in real-time, removing the need for the administrative headache of filing a tax return with the Australian Taxation Office (ATO) every year. While this might seem convenient, it also represents a significant shift in the level of financial privacy and autonomy that Australians currently enjoy.

Australia’s research into a CBDC is in its early stages. Around the world, other countries are a little further along with digital currencies.

According to the Atlantic Council’s GeoEconomics Center’s Central Bank Digital Currency (CBDC) Tracker, three countries have fully launched a digital currency and 36 are currently piloting them. China’s digital yuan, one of the largest CBDC programs, launched its pilot project in 2014.

“They are testing a pilot in five cities. They gave out millions in currency through lotteries just to prove it works,” according to Jim Cunha, executive vice president and interim chief administrative officer at the Federal Reserve Bank of Boston in the US. People who win the lottery receive free CBDC, which they can spend at local shops that accept it.

While it’s not at a national scale yet, once China has the platform ready, it will expand through banks and mobile providers like Alipay.

The central banks of China and the United Arab Emirates are also working on a project to use blockchain and CBDC for regional payments between nations. If these projects are a success, they could give more motivation to other nations to create their own CBDC.

However, the already contentious social credit score system in China has cast doubt on the good intentions of the digital Yuan. The credit score system, which is designed to score an individual’s, or company’s, trustworthiness, can be great for those who score highly and very detrimental for those who score poorly. There are ethical concerns that this system could be extended to China’s CBDC, financially restricting those with lower scores.

Lilya Tessler, head of Sidley’s FinTech and Blockchain group, is optimistic about the future use of digital currencies. “We certainly will see mass adoption of digital currencies, but it is difficult to predict how it will look. ”

If  Australia adopts a CBDC, it would work as an alternative to cash. As Australia’s banking system is one of the most sophisticated in the world, with cross-bank payments possible in seconds, many are wondering what the purpose of a CBDC would be.

Cunha has a few ideas on what this would look like for consumers in the US, which could be used to draw parallels to a potential CBDC in Australia. “Our presumption is that it will be free or near free, like cash. Other private sector players may innovate on top of it and possibly additional fees, but that has to be fleshed out more,” he says.

Even though a digital currency would be electronic, it still needs to be as accessible as cash.

“Anyone should be able to use it, not just those with the latest smartphones,” Cunha said, suggesting chip-based cards, point-of-sale systems and web accounts as alternative ways to access the CBDC. He also believes a way to handle transactions offline will need to be developed, so two people can exchange CBDC even if they aren’t on a cell or WiFi network.

There’s a lot to be done, and a lot of industry input needed.

“While no decision has been made to move past this research, I truly believe CBDC should be fully investigated and holds great potential,” he said. “Just think of the internet and how far it’s come since the early days. With CBDC, the possibilities are endless.”

While proponents argue that a CBDC could offer some advantages, many Australians may find that it offers little additional benefit beyond the current financial system. Moreover, the implementation of a CBDC could potentially grant the RBA and government increased control over financial transactions, raising significant privacy concerns.

Given Australia’s already advanced and efficient banking infrastructure, the case for introducing a CBDC remains a subject of ongoing debate.

• Legality and Acceptance: When compared to decentralised currencies, a CBDC, being backed by the government, would be deemed legal tender in Australia. All economic actors must accept it for any legal purposes, including tax payments and loan repayments. However, when compared with the current system, a CBDC has no advantage over regular AUD.
• Simplicity in taxation: Given the programmable nature of digital currencies, the central bank could design a taxation system that operates at the transaction level. This would allow for real-time taxation during each transaction, potentially eliminating the need for annual tax submissions.
• Innovation Potential: As with the evolution of the internet, the introduction of a CBDC could stimulate innovation in the Australian financial landscape, possibly leading to new financial products and services.

• Increased Control and Decreased Privacy: The introduction of a CBDC would give the RBA and the government significant control over the financial activity of Australians, raising concerns about financial freedom and privacy.
• Potential for Manipulation: The controlling entity can potentially alter the transaction history and manipulate the supply of the currency. While the RBA already has control of the supply of the AUD, the increased programmability of a CBDC further amplifies this power. If used incorrectly, it could lead to outcomes that are not in the best interests of Australians
• Single Point of Failure: CBDCs are centralised, meaning there is a single point of failure. This single point of failure, while giving immense control to those in charge, comes with a central risk. If the governing authority is hacked or taken over, a bad actor could control the entire system. This is why decentralised currencies were created.
• Limited Benefit Beyond Current System: Given that Australia’s financial system is highly advanced, with cross-bank payments possible in seconds, the introduction of a CBDC might offer limited tangible benefits beyond what is currently available.

CBDCs are no different than an issuing nation’s existing monetary supply. CBDCs are meant to mimic the price of the nation’s existing currency and investing in CBDCs is just like holding a nation’s physical cash in your hand today.

However, right now, foreign nationals can’t hold the CBDCs of any other government in their digital wallets. In other words, an Australian can’t currently access Bahaman “sand dollars.”

You need a verified username and bank account to hold a CBDC from any nation today, you need a verified username and bank account. This means citizens of different countries can’t have a foreign nation’s CBDC distributed to them. Most experts believe, though, that this will change as more CBDCs are implemented worldwide.

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