Digital is not always the answer

The growing global attention to central bank digital currencies (CBDCs) marks a significant advancement in finance and technology. While CBDCs are not a new concept, their potential benefits have gained considerable global attention in recent years. Issued by central banks, these regulated digital versions of cash promise improved security, stability, and efficiency than traditional cryptocurrencies. The journey of CBDCs dates back to 1993 when, the Bank of Finland introduced the Avant smart card, considered the world's first CBDC. Although the bank eventually discontinued this system, it laid the foundation for future advancements in digital currencies. Today, with technological progress and the waning use of physical cash, central banks across the globe are actively investigating the potential of CBDCs to improve payment systems' efficiency and safety. Notwithstanding the numerous potential benefits of CBDCs, central banks must carefully evaluate its demand and make a compelling case for their implementation before mainstreaming digital currency.

Countries and central banks must first grasp this fundamental understanding and continue to focus on further research and development through investments and resource allocation.

Contextual Solutions 

While there is little doubt about CBDCs’ immense benefits, it is crucial to recognise that the mere transition to digital forms of currency does not automatically resolve existing monetary issues. While CBDCs offer a wide range of potential solutions, they cannot be seen as a one-size-fits-all remedy. Countries and central banks must first grasp this fundamental understanding and continue to focus on further research and development through investments and resource allocation. They must carefully consider and analyse the specific challenges CBDCs can address effectively, and how CBDCs could be designed and implemented with a thorough understanding of their potential benefits and limitations. Such an approach will enable countries and central banks to harness the true transformative power of CBDCs while avoiding unrealistic expectations. 

Digital Quagmire

To address currency challenges and facilitate transactions, the Reserve Bank of Zimbabwe has launched a gold-backed digital currency. This initiative aims to enable peer-to-peer and peer-to-business transactions while providing a store of value amid the depreciation of the national currency. However, the reception of this gold-backed digital currency has been lukewarm. Although the backing by gold can potentially absorb excess liquidity and offer relative stability to the local currency, it fails to tackle the deep-rooted currency issues haunting in the Republic of Zimbabwe. It also fails to address the fundamental issues of confidence and trust among the population. Introducing such currencies is often perceived as catering to the affluent while neglecting the plight of ordinary citizens trapped in extreme poverty.

Former Finance Minister Tendai Biti suggests an alternative approach, urging the central bank to prioritise the establishment of market stability by allowing the Zimbabwean dollar to float freely.

With a history of hyperinflation and a reliance on multiple currencies, such as the US dollar and the Zimbabwean dollar, the nation faces underlying challenges that the mere introduction of a digital currency cannot address. Zimbabwe adopted the US dollar in 2009 and later introduced bond notes to stabilise its currency. Unfortunately, these measures, too, proved ineffective in halting the swift devaluation of the Zimbabwean dollar against major currencies. Thus, the introduction of CBDC could only be part of a larger strategy aimed at continued re-dollarisation. Former Finance Minister Tendai Biti suggests an alternative approach, urging the central bank to prioritise the establishment of market stability by allowing the Zimbabwean dollar to float freely. This approach highlights the need for comprehensive solutions that address Zimbabwe’s economic and societal complexities, going beyond the mere introduction of digital currencies.

Building on shaky ground

In Nigeria, too, the introduction of the eNaira, a government-backed digital currency in 2021, has failed to meet its intended objectives and has left digital currency users in the country questioning its efficacy. With a meagre adoption rate of less than 0.5 percent of the population, amounting to fewer than 1.15 million Nigerians, eNaira has failed to make any significant impact. Several factors can account for its limited success. Compared to more sophisticated and adaptable cryptocurrencies like Bitcoin, eNaira is perceived as lacking in functionality and competitiveness. Moreover, its centralised, government-led nature has bred scepticism among the populace, who harbour concerns about divulging their financial information directly to the authorities. The popularity of cryptocurrencies among Nigerians stems from their ability to safeguard against inflation, the devaluation of the local currency, and restrictive regulations on international transactions. For the country's youth, a significant segment of cryptocurrency users, the eNaira fails to offer compelling reasons to switch from their existing banking applications, as it provides similar services without notable advantages. Additionally, limited internet accessibility in rural areas has hindered eNaira’s widespread adoption.

The pursuit of the digital lira, considering the significant devaluation of Türkiye's fiat currency, has led Turkish citizens to show interest in alternative digital assets, such as Bitcoin.

Despite initial interest, eNaira’s utilisation remains primarily confined to government-led social welfare programmes, with only a few households and merchants embracing the platform. The sluggish pace of adoption and the insignificance of transaction values shed light on the challenges faced by eNaira in gaining broad acceptance within Nigeria. Turkey could also be gradually moving towards a similar problem. Turkey's central bank recently declared the completion of initial tests for the digital lira. The pursuit of the digital lira, considering the significant devaluation of Türkiye's fiat currency, has led Turkish citizens to show interest in alternative digital assets, such as Bitcoin. Nonetheless, doubts persist as to whether a digital lira can effectively address the underlying economic obstacles faced by the nation.

Back to Basics 

The world is witnessing a growing fascination with digital currencies, and central banks are joining the bandwagon. It is crucial to understand that simply adopting a digital approach won't be a panacea. On the contrary, it might give rise to new challenges. Introducing CBDCs could be smoother in countries with political stability, strong institutions, and sound macroeconomic policies. The promises of digital currencies are likely to remain unfulfilled without these essential preconditions. Moreover, infrastructure plays a pivotal role; accessible and affordable internet is the bedrock for such technological leaps.

Offering stability and potential advantages in terms of lower transaction costs and increased efficiency, the digital rupee aims to provide digital mobility compared to physical currency notes.

The Reserve Bank of India introduced the Digital Rupee in 2022 to propel India's position in the digital currency landscape. Offering stability and potential advantages in terms of lower transaction costs and increased efficiency, the digital rupee aims to provide digital mobility compared to physical currency notes. However, with the existence of a robust payment system like UPI (Unified Payments Interface), the question arises as to whether CBDCs can enhance the current landscape. Emerging nations must grasp that developed countries hold significant advantages, and their solutions might not be universally applicable. Context matters profoundly. Before embracing digital currencies, central banks need a deep understanding of their nation's prerequisites. Although digital currency holds vast potential, it requires investing in foundational blocks. It is essential to focus on robust macroeconomic policies, digital literacy, and supporting entrepreneurs and businesses, as digital currency alone cannot be a magical remedy for a nation's economic challenges.

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Sauradeep Bag is Associate Fellow at Observer Research Foundation.

• International Affairs
• Internet Governance
• Cyber and Technology
• India
• USA and Canada
• AVANT SMART CARD
• CBDCS
• DIGITAL LIRA INFRASTRUCTURE
• GOLD-BACKED DIGITAL CURRENCY
• HYPERINFLATION
• security

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