What is “central bank digital currency” (CBDC)?

Central banks are closely monitoring the situation of digital currencies. First of all, do you know “what is a central bank digital currency”?

Central bank digital currencies, or CBDCs as many people prefer to call them, are a form of digital currency issued by a country’s central bank. What is interesting, central bank digital currencies are similar to cryptocurrencies. However, its 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 summarize, fiat money is currency issued by a government that is not 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. However, it is not as popular as it used to be several years ago. The Covid-19 pandemic hastened the demise of fiat currency.

New technologies have the potential to make fiat currency even less popular. As expected, 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 do not have a bank account for various reasons.

The question is, what is the main goal of CBDCs?

The primary goal is to provide both businesses and consumers with privacy, convenience, financial security, portability, and accessibility. Additionally, CBDCs also have the potential to reduce cross-border transaction costs.

Furthermore, they also have the potential to reduce the risk of using digital currencies in their current form. It is a well known fact that cryptocurrency is extremely volatile. What about CBDCs?

A government backs them. Furthermore, they are under the control of a central bank. Therefore, they are much more stable compared to cryptocurrencies.

Types of CBDCs

Don’t worry! There are not numerous types of CBDC. On the contrary, there are only two types, wholesale and retail.

We can start with the first. 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 note that retail CBDCs are government-backed digital currencies. As stated above, they are used by consumers and businesses. The important thing is that they eliminate the risk of intermediaries. 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 can be accessed with private/public keys. Importantly, this validation method allows people to make transactions anonymously.

The situation is different in the case of account-based retail CBDCs. This type of retail CBDC requires digital identification to access an account.

Cryptocurrencies vs. central bank digital currencies

What is the difference between cryptocurrencies and CBDCs?

It is difficult to duplicate cryptocurrencies. In addition, they are protected by consensus mechanisms that prevent their manipulation. Interestingly, CBDCs are designed to be similar to cryptocurrencies. However, CBDCs may not require blockchain technology or consensus mechanisms.

As a reminder, cryptocurrencies are unregulated and decentralized. We must bear in mind that its value is dictated by investor sentiment, usage, and user interest.

Cryptocurrencies are extremely volatile. Therefore, they are more suitable for speculation. What about CBDCs? They reflect 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 to determine the feasibility and usability of a CBDC. More than 80 countries are exploring CBDCs. It’s a good idea to take a look at some of them.

In 2022, the Jamaican central bank launched the digital version of the country’s currency. Interestingly, JAM-DEX became the first CBDC to be formally ratified as legal tender.

The aforementioned CBDC is not blockchain-based, unlike the Eastern Caribbean Central Bank DCash and the 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 the Aber project.

CBDC and risk factors

The road to adoption is full of challenges. For example, when money goes digital, the money also becomes traceable and therefore taxable.

Interestingly, analysts anticipate that this will become an obstacle to voluntary adoption. There are other problems too. Another problem is the 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 technology issues in 2022.

Furthermore, there are concerns that the business case for central bank digital currencies is quite weak. It will not be easy to develop infrastructure for digital currencies.

Additionally, the central banks of some nations, such as Singapore and Canada, have concluded that there is currently no strong case for a CBDC.

China and its position on CBDCs

The position of the People’s Republic of China is quite interesting. As a reminder, private cryptocurrency is prohibited in the country.

Nonetheless, China is interested in a central bank digital currency. For one thing, China is not a big fan of cryptocurrencies. On the other hand, the People’s Bank of China, which is the country’s central bank, worked to create a CBDC. Importantly, the country’s central bank has created the most advanced market application of a CBDC to date.

Interestingly, e-CNY relies on private banks to distribute and maintain these accounts for its clients. It is worth noting that digital e-CNY is a central bank digital currency issued by the central bank of the country.

Several years ago, the People’s Bank of China began testing e-CNY through app- and wallet-based payments for government services, transportation, and other consumer lifestyle use cases. The government of the country wants to make e-CNY more popular across the country.