In this article, we will examine a financial system, specifically the payments part, fully based on a digital currency.

Let us first clarify what we are looking at: A digital currency is any kind of money that does not have a physical form. Most common versions are cryptocurrencies, see 51 Types of cryptocurrency for more explanation, and Central Bank Digital Currency or CBDC: A digital (not physical) version of the currency for the country to which the central bank belongs. We will focus on the latter and assume all digital currencies are fully tied to the central bank.

Digital payment system

The primary goal of a digital payment system is to offer a high-speed, fully accepted way too pay for something, both as a private person and acting as a corporate entity.

Please be aware that a digital system is not the money you have in a bank account, accessed online (digitally); that is regular money, stored in an online bank account.

Advantages

• First and foremost, it is about convenience; using physical cash means transporting and counting the money, which takes working hours while there is an alternative.
• A fully centralised system could process all transactions with virtually no delay and at low costs. In theory, only the cost of maintaining the system itself plus payment terminals, central banks are already funded via taxes so no additional costs need to apply. With regular money, depositing and wiring amounts are paid for services, if you have a business account. Some costs that currently exist would continue, as the method used for paying in stores remain active.
• The requirement for central banks to guarantee deposits, generally up to a specified amount, becomes much simpler: If the bank fails, all records of who owns what should be in the files of the digital currency. Which happen to be at the central bank.
• Some institutions will become obsolete, saving steps on a regular basis ultimately reduces overall costs for all parties. However, switching to a digital currency does not mean that actual cash money has to be outlawed, so some parties can continue to operate. Both forms of money have a different infrastructure, so they can coexist.
• Fully digital payments can serve as a bank, for the currently unbanked. Those who currently do not have bank accounts, often lack them because of remote locations or high risk areas. So the need for a non-physical form of banking is very real. We do recommend a full assistance program, plus designing with end users in mind, as the unbanked tend to not have a lot of experience in payments via electronic devices. A point (trading hub, or big village) where they can get, or deposit, physical cash is advised, to ease the transition. We are assuming an internet connection for this to work, which may not be the case, a satellite can fix this if required.
• In 60 Negative consumer interest rates we listed a mismatch between consumer interest rates and the rates set by central banks as a reason why the negative rates were not 100% effective. With Central Bank Digital Currency, this would no longer be the case, as all deposits are directly tied to the central bank.

Disadvantages

• Relying on a digital only, fully centralised system, poses a big risk for potential problems.
• As said by every activist, every time such a system was discussed: All privacy is gone, when it comes to what you spend money on. Note that currently banks, in some countries, actively monitor transactions since they are mandated by law to search for criminal/terrorist activities.

• Requires a solid digital infrastructure, that needs to be compatible with both traditional and cross border infrastructures. It is likely that multiple systems need to coexist for several years, as both people and third party (think payment terminals and how banks process payments) systems adjust. Banks will have a tough time, as the amount of money deposited with them is reduced, thereby severely limiting their lending capacity.
• There is a risk that cryptocurrencies move faster and become more trusted than the here discussed official digital currency. In such a case there are two choices: 1 Using the Central Bank Digital Currency becomes legally mandated for, with no exception. Cryptos can still exist, but only as investments or secondary payment option. 2 The gauntlet is picked up by central banks, who raise their game and provide a better product, presumably with useful cross system functions or an ecosystem.
• There is no delay in settlement, any error is immediately enacted; releasing the hounds before crying havoc. In the current system settlements usually happen at the end of the day, sometimes multiple days, so there is time to correct something. There are legal concerns (these could be hammered out before implementing the system) to which record is correct: The fault, as it is part of official data, or the correct version, that was not entered.
• The state would face fewer hurdles when meddling with bank accounts with a digital payment system.

Role of cryptocurrencies

As stated in the introduction, we do intend the digital payment system to be a type of cryptocurrency. We will use it as an inspiration and potentially base part of the structure on it, such as using an adapted version of the underlying technology.

Cryptocurrencies have a base infrastructure, on which other crypto assets are build. A CBDC could copy this making one single central hub for all global activities. Other countries or specific banks could be allocated their own sub systems, to somewhat separate them. This does not reduce risks from actual problems, more as a just in case it helps kind of solution; better to have to fix the system of a single bank then the entire system.

As a form of competition, crypto has a long way to go. They are a potential investment and accepted as form of payment in myriad stores, but that is a long way from becoming the thing in which salaries and rent are paid, by the public. For that hurdle to be taken; a price stability on no more than a reasonable level of inflation is required. Plus a lot more security, such as the guarantee that some central banks offer on deposits, in case something happens to the bank. Banks have to comply with a huge amount of regulation, the same would apply to crypto exchanges plus any other parties involved in creating and/or distributing them.

Note that it is fully possible that without cryptocurrencies we would not be having as much development in CBDCs as is the case, in part due to the potential competition of free market agents making their own cryptos to offer digital alternatives to official currencies.