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A CBDC is a type of digital currency issued and controlled by a country's central bank. Eleven countries, including the Caribbean and Nigeria, already have CBDCs in place.
Key Takeaways
• A CBDC is a type of digital currency that is issued and controlled by a country's central bank.
• The value of one unit of a CBDC remains equivalent to that of one unit of the country's fiat currency.
• CBDCs are an asset class that are being fostered by central banks to combat the volatile category of cryptocurrencies in the market.
Central bank digital currencies (CBDCs) are in the news again as the Bank of International Settlements (BIS) announced a new project around CBDCs a few days ago.
According to the latest update, the BIS will advance CBDC privacy research in 2024, BIS Innovation Hub head Cecilia Skingsley said. The research is part of the Project Aurum, based out of the organisation’s Hong Kong Centre. The project was first launched in 2021 to explore the front and back end of a multi-use CBDCs.
“Project Aurum enters a new phase in which it will study the privacy of payments in retail CBDCs. The goal is to leverage expertise from academia and privacy regulators to advance central banks' understanding of privacy in the design of CBDC systems,” the announcement read.
CBDCs have gained currency in the financial world because the segment offers customers exposure to the decentralised finance (DeFi) ecosystem while guaranteeing the assurance of a central authority. It is important that we understand the concept of CBDCs, a class of cryptocurrency that bridges the gap between blockchain technology and centralised economic model. Let’s dive right in.
As it names alludes to, CBDC is a type of digital currency issued and controlled by a country's central bank. The bank fixes the value of a CBDC one unit of which remains equivalent to that of one unit of the country's fiat currency. One CBDC is the digital representation of the issuing country’s one unit of national fiat currency. Here's how CBDCs evolved:
• Traditionally, central banks have issued fiat currencies in physical form such as notes or coins that are a form of legal tender.
• While digital payments became popular with the advent of Web2, CBDCs are a relatively new development which took place after the advent of Web3.
• It was the blockchain technology, central to the DeFi ecosystem, that popularised cryptocurrency as a new type of virtual currency.
• A cryptocurrency lies outside the control of a central authority such as the central bank or the central monetary authority. Thus began the era of DeFi sector.
• The general masses became very interested in the crypto economy during its phases of boom and made a lot of money during those bull runs. But they also lost billions when the crypto market collapsed. This cycle of rally and collapse took place multiple times.
• Later, governments from around the world recognised the concerns of these traders and realised the potential of the blockchain technology to develop their own centralised digital currencies.
• This gave birth to the idea of CBDCs.
• Besides, we also witnessed a consistent decline is cash usage in the economies of developed countries. The central banks were then compelled to respond to these trends.
• CBDCs are indeed digital currencies, but they are issued and controlled by central banks.
• Unlike cryptocurrencies, CBDCs are not decentralised or trustless.
• With CBDCs, governments are trying to turn the idea of a decentralised economy upside down.
• In a way, the central banks are trying to adopt the foundational technology of cryptocurrency to their own benefit, taming the Wild West dream of the crypto industry.
Two types of CBDCs exist:
• Wholesale CBDCs: An institution holds an account in a central bank to store wholesale CBDCs or interbank fund settlements. Similar to other kinds of reserves, central banks are free to deploy the conventional instruments of monetary policy, such as reserve requirements or interest on reserves, to influence interest rates and lending.
• Retail CBDCs: Governments issue retail CBDCs for financial interactions among regular customers. A retail CBDC can either be token-based or account-based and can be accessed by retail customers as per their convenience. While the former is primarily used by financial institutions, the latter is primarily used by retail consumers and businesses.
In 1993, the Bank of Finland introduced the Avant smart card. It was a form of e-cash. A lot of financial experts consider the Avant smart card the Avant smart card to be the world's first CBDC. But it wasn’t exactly a CBDC is the way we understand it. In fact, it was the Bahamas that introduced the world’s first CBDC, the Sand Dollar, in 2020.
• 11 countries, including the Caribbean and Nigeria, already have a CBDC in place.
• 19 of the G20 countries are now in the advanced stage of CBDC development.
• So far, a total of 130 countries and currency unions, or 98% of the global GDP, are exploring the opportunities of CBDC, with development in different stages.
• Jamaica launched its CBDC, JAM-DEX, in 2022. It is the first CBDC that is recognised as legal tender.
The reason CBDCs have gained popularity is because of the inaccessibility of banking and financial services for masses across countries. Often, illiteracy, poor financial status, and other such adverse conditions of a large number of people are the reasons why such services remain inaccessible to them. This is where CBDCs come in.
Recommended Read: Why is Financial Literacy Important?
• Anyone with an internet condition can purchase CBDCs and access banking services directly. CBDCs offer financial services to low-income individuals at very modest costs.
• CBDCs offer the benefits of privacy, ease, accessibility and security to enterprises and individuals executing their financial activities using CBDCs.
• Built on the blockchain network, CBDCs do not have to maintain a large financial system and thus save a large amount of maintenance and cross-border transaction costs in the process.
• CBDCs don’t carry the risks generally associated with cryptocurrencies, given the fact that CBDCs are issued and controlled by the central banks.
• In comparison to cryptocurrencies, CBDCs are stable and considerably immune to price volatility. Therefore, CBDCs offer a wall of protection to those low-income households against possible financial hardship.
• CBDCs, offering the protection of governments and central banks, give a sense of stability to those accessing these currencies.
CBDCs are also meant to reduce the cost of supporting a complex financial structure. Financial inclusion is also a major goal of the enterprise. The main advantages offered by CBDCs to users are:
• Transferability: It is easy to transfer CBDCs to other accounts such as those belonging to family, friends, or other acquaintances.
• Convenience: CBDCs are very convenient to ordinary users as they are digital representations of the national currencies only. It is easy to make fiat-to-CBDC conversion and vice versa.
• Accessibility: Complete control and regulation by a central authority make CBDCs accessible to a large number of users in a country.
• Financial Security: Issued by the central bank, CBDCs are considered to be as secure as fiat currency.
The noise surrounding CBDCs has generated so much excitement that it’s easy to forget that they have a few disadvantages as well that users need to be aware of:
• Complete Centralisation: CBDCs are completely centralised, making them unattractive to a userbase that is averse to authority and is actively looking to become a part of the decentralised economy.
• Lack of Privacy: You give up privacy to central institutions the moment your money is controlled by a central authority.
• Limited Adoption: Since digital representation of fiat currencies already exist in the form of UPIs, debit or credit cards, internet banking services etc., not a lot of users have shown much enthusiasm for CBDCs.
However, faster transaction rates might lead to wider adoption.
The chief differences between CBDCs and cryptocurrencies are:
• CBDCs are distinct from cryptocurrencies in that the latter are highly volatile which can prove to be disastrous for a national economy.
• CBDCs, on the other hand, are issued, backed, and controlled by a central bank.
The involvement of a central authority gives many users the confidence of interacting with a new form of currency.
Most experts are certain that CBDCs have the potential of influencing the global financial order. CBDCs are still in their infancy if we look at the broader picture of the modern and digitised financial system. As the adoption, usage and growth of CBDCs expands across countries over time, we can then observe the trends in the global economy that will emerge.
Related: The Future of the Financial System
Financial services providers are now working towards enhancing their infrastructure to integrate with CBDCs within the next few years. These institutions include large international banks, fintech companies, online marketplaces and merchants. It won’t be long before CBDCs become a preferred mainstream option for domestic or cross-border payments, such as credit cards and online banking.
The performance of the DeFi market, particularly the crypto market, over the next few years, will also influence whether CBDCs will witness wider adoption. If these markets remain volatile as ever, we can surely witness a growth in the adoption of CBDCs.
As far as we can observe, the crypto economy will perform like it has been since its beginning—volatile and unpredictable. Even cryptocurrencies are now increasingly getting regulated by government authorities across the world. So, those traders who are looking to invest in a stable digital currency will opt for CBDCs.
A central bank digital currency (CBDC) is a type of digital currency issued and controlled by a country's central bank. One CBDC is the digital representation of the issuing country’s one unit of national fiat currency.
The value of a CBDC is determined by the central bank of the issuing country; one unit of CBDC is equivalent to one unit of the country's fiat currency.
The two types of CBDCs are:
• Wholesale CBDCs: An institution holds an account to store wholesale CBDCs or interbank fund settlements.
• Retail CBDCs: Governments issue retail CBDCs for financial interactions among retail customers.
The benefits of CBDCs are:
• Financial inclusion and security
• Transferability
• Convenience
• Accessibility
The drawbacks of CBDCs are:
• Complete centralisation
• Lack of privacy
• Limited adoption
The Bahamas first introduced the world’s first CBDC in 2020.
In total, 3 countries, i.e. the Bahamas, Jamaica and Nigeria, have fully launched a CBDC. In fact, 134 countries and currency unions are exploring CBDCs.
First, apply for a digital wallet and then purchase the amount of CBDC you are interested in. The digital currency then gets reflected in your wallet.
A CBDC is issued and controlled by the issuing country’s central bank.
• A CBDC is fundamentally different from a cryptocurrency:
• A CBDC is a completely centralised digital currency; on the other hand, a cryptocurrency is decentralised.
• A CBDC is issued and controlled by a country’s central bank. A cryptocurrency, however, lies outside the purview of any governmental authority.
This article is for informational purposes only and not intended as investment or financial advice. It contains opinions and speculations that are subject to change without notice.
The author and publisher disclaim any liability for decisions made based on the content of this article. Readers are advised to conduct their own research and consult a financial advisor before making investment decisions.
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