Central Bank Digital Currency (CBDC): What Is It?
A digital counterpart of fiat money that is backed by the government is known as a central bank digital currency (CBDC). A central bank issues this kind of digital money, which is connected to the nation’s currency.
The stablecoins, which are cryptocurrencies tethered to fiat currency and aim to keep the same value, are the ones that CBDCs are most comparable to. The primary distinction is that governments all over the world issue CBDCs.
Around the world, more than 80 nations are engaged in various phases of CBDC research and development. Others have already launched their digital currencies, while some have idle or abandoned initiatives. Understanding CBDCs is crucial if you plan to invest in cryptocurrencies since they may have an impact on the crypto market.
How does CBDC work?
Each CBDC functions similarly to a nation’s current fiat currency since it is a digital equivalent of that currency. There may be variations in how they operate because other countries are developing their own CBDCs, but they all adhere to the same fundamental paradigm.
The federal government supports the CBDC that the country’s central bank issues. In subsequent transactions, such as paying employees or making purchases of goods and services, that CBDC can be used as legal cash.
This could seem like something we already have. After all, you may digitally transfer money from your bank account to a friend’s account at a different bank. This kind of transaction would not have to go through several banks or take several business days if there were a CBDC. All of this could take place on a single digital ledger almost instantly.
Additionally, consumers might utilize a CBDC without having a business bank account. CBDCs would give unbanked people a method to send money electronically.
Types of CBDCs
CBDCs come in two varieties: retail and wholesale, as well as hybrids that mix features from both. Here are some differences and details on how they operate.
Retail central bank digital currencies
Retail CBDCs are distributed to the general public. Customers can store a CBDC in a wallet or account and use it to make purchases using this method.
This kind of CBDC would function as an open source, universally accessible digital banking solution. Customers who are unable to use standard banking services may find it extremely useful. Since the money is backed by the government, there is also no chance of a bank failure.
Many nations, including the United States, have decided to adopt the retail CBDC model. The Bahamas, which launched a widely accessible CBDC first, likewise went with the retail approach.
Wholesale central bank digital currencies
The adoption of wholesale CBDCs is anticipated from the banking sector. A central bank’s CBDC might be used by banks and other financial institutions to improve money transfers and transaction settlement. While this kind of CBDC would boost local payment efficiency, it might also be highly beneficial for international payments.
Increased security is a further advantage of a wholesale CBDC. These currencies’ use of a digital ledger to process and record transactions could make it easier to avoid financial fraud.
A few countries, like Singapore, Malaysia, and Saudi Arabia, are concentrating on a wholesale CBDC. However, the majority are working on either a retail or hybrid CBDC.
CBDCs’ benefits and drawbacks
- Payments that are more reliable and secure.
- Give customers immediate access to the central bank.
- Reduce the possibility of a commercial bank failing.
- Tracking is simple.
- Complete control rests with central banks.
- Less privacy for users.
- It is challenging to get widespread adoption.
- Potential rivalry between central banks and private banks.
Central bank digital currency vs. cryptocurrency
The CBDC is not a cryptocurrency. Despite the fact that cryptocurrencies were the inspiration for CBDCs, they are two completely distinct kinds of digital currency.
Centralization is the main distinction between CBDCs and cryptocurrencies. A cryptocurrency is a decentralized digital money, which means that it is not governed by a single entity. The public, distributed ledger known as a blockchain is where transactions are processed and recorded. A central bank controls a central bank digital currency, as the name suggests.
Additionally, cryptocurrency offers far more anonymity than CBDCs. Transactions are transmitted and received using wallet addresses, and some level of privacy may be maintained. Some cryptocurrencies are even said to be untraceable. The central bank will have a record of users and their transactions thanks to a CBDC.
Examples of CBDCs
There are several CBDCs that have been released, but the majority are still in research or development. Here are a few CBDCs that are either on the market or being tested in multiple countries:
- The Sand Dollar, a digital representation of the Bahamian dollar, has been introduced by the Bahamas. It is distributed by accredited financial institutions on behalf of the Central Bank of the Bahamas.
- A digital yuan, commonly referred to as a digital renminbi or digital RMB, is being tested in China. China has advanced the most in creating the CBDC among the top economies.
- The eNaira, which keeps track of transactions on a centralized blockchain ledger, is being introduced by Nigeria. It is the first country in Africa to establish a CBDC.
Although the U.S. is one of the countries with the largest banks and is now examining the costs and advantages of establishing a CBDC, the Atlantic Council claims that it is the country that is lagging the most behind.
CBDCs are still in their infancy, but it’s obvious that they’re a concept that’s gaining popularity. Over 90% of the global gross domestic product (GDP) is produced by the nations that are researching them . Even while CBDCs might not completely replace cash, most nations will most certainly at least partially adopt their own digital currencies.