Central banks are closely monitoring the situation regarding digital currencies. First of all, do you know “what is a central bank digital currency”?
Central bank digital currencies, or CBDC as many people prefer to call them, are a form of digital currency that is issued by a country’s central bank. What’s interesting, central bank digital currencies are similar to cryptocurrencies. However, their value is determined by the central bank and is equivalent to the country’s fiat currency.
Many countries are interested in central bank digital currencies. Interestingly some countries have already implemented them. It is vital to understand what they are and how they could change the world.
To cut a long story short, fiat money is a currency issued by a government that isn’t backed by a physical currency. Importantly, fiat money is considered a form of legal tender.
We need to mention that fiat currency is still widely used around the world. Nonetheless, it isn’t as popular as it used to be several years ago. The Covid-19 pandemic accelerated the demise of fiat currency.
New technologies have the potential to make fiat currency even less popular. Unsurprisingly, governments and central banks are closely monitoring the situation. Many governments, as well as central banks, are exploring the possibility of using government-backed digital currencies.
Central bank digital currencies and new opportunities
Now, you know what to answer if someone asks, “what is central bank digital currency?”
The topic of central bank digital currencies is quite interesting, to say the least. So, let’s learn more about CBDCs.
Millions of people, even in developed countries, lack access to financial services. Yes, there are many people who don’t have a bank account due to various reasons.
The question is, what is the main goal of CBDCs?
The main goal is to provide businesses as well as consumers with privacy, convenience, financial security, transferability, and accessibility. Furthermore, CBDCs also have the potential to reduce cross-border transaction costs.
Moreover, they also have the potential to reduce the risk of using digital currencies in their current form. It is a well-known fact cryptocurrency is extremely volatile. What about CBDCs?
A government backs them. Moreover, they are under the control of a central bank. So, they are far more stable compared to cryptocurrencies.
Types of CBDCs
Don’t worry! There aren’t numerous types of CBDCs. On the contrary, there are only two types, wholesale and retail.
We can start with the first one. It is important to note that financial institutions primarily use wholesale CBDCs. What about retail CBDCs? Consumers, as well as businesses, use them.
It is desirable to keep in mind that retail CBDCs are government-backed digital currencies. As stated earlier, they are used by consumers and businesses. What’s important is that they eliminate intermediary risk. So, you don’t have to worry about private digital currency issuers.
Retail CBDCs are divided into token-based retail CBDCs and account-based retail CBDCs.
Interestingly, token-based retail CBDCs are accessible with private/public keys. Importantly, this method of validation enables people to carry out transactions anonymously.
The situation is different in the case of account-based retail CBDCs. This type of retail CBDC requires digital identification in order to access an account.
Cryptocurrencies vs. central bank digital currencies
What is the difference between cryptocurrencies and CBDCs?
It is hard to duplicate cryptocurrencies. Moreover, they are protected by consensus mechanisms that prevent tampering. Interestingly, CBDCs are designed to be similar to cryptocurrencies. However, CBDC may not require blockchain technology or consensus mechanisms.
As a reminder, cryptocurrencies aren’t regulated and are decentralized. We need to note that their value is dictated by investor sentiments, usage, as well as user interest.
Cryptocurrencies are extremely volatile. So, they are more suited for speculation. What about CBDCs? They mirror the value of fiat currency. They are more stable and secure.
Central banks and their plans
Central banks in many countries have launched pilot programs in order to determine the viability and usability of a CBDC. More than 80 countries are exploring CBDCs. It is a good idea to take a look at some of them.
In 2022, Jamaica’s central bank launched the digital version of the country’s currency. Interestingly, JAM-DEX became the first CBDC to be ratified formally as a legal tender.
The above-mentioned CBDC isn’t blockchain-based, as opposed to the Eastern Caribbean Central Bank’s DCash and Bahamas’ Sand Dollar.
Nigeria is also interested in CBDCs. It launched eNaira in 2021. Nigeria has become the first African country to launch a CBDC.
Other countries are also exploring CBDCs. For example, the central banks of the United Arab Emirates and Saudi Arabia tested the use of a jointly issued digital currency as part of project Aber.
CBDCs and risk factors
The road to adoption is full of challenges. For instance, when money becomes digital, the money also becomes traceable and, therefore, taxable.
Interestingly, analysts anticipate this to become an obstacle to voluntary adoption. There are other problems as well. Another problem is a lack of technological stability. However, the situation may change in the future.
As a reminder, the digital version of Eastern Caribbean DCash was offline for two months due to technological issues in 2022.
Besides, there are concerns that the business case for central bank digital currencies is quite weak. It won’t be easy to develop infrastructure for digital currencies.
Moreover, central banks in some nations, such as Singapore and Canada, concluded that there isn’t currently a strong case for a CBDC.
China and its position regarding CBDCs
The position of the People’s Republic of China is quite interesting. As a reminder, private cryptocurrency is banned in the country.
Nonetheless, China is interested in a central bank digital currency. On the one hand, China isn’t a big fan of cryptocurrencies. On the other hand, the People’s Bank of China, which is the country’s central bank, worked in order to create a CBDC. What’s important, the country’s central bank has created the most advanced market application of a CBDC to date.
Interestingly, e-CNY relies on privately-owned banks in order to distribute and maintain these accounts for their clients. It is worth noting that digital e-CNY is a central bank digital currency issued by the country’s central bank.
Several years ago, the People’s Bank of China began testing e-CNY through the app- and wallet-based payments for government services, transportation, and other consumer lifestyle use cases. The country’s government wants to make e-CNY more popular around the country.