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In recent times there has been a huge hype about the Central Bank Digital Currency which is also known as CBDC. But what is CBDC and how is it different from a cryptocurrency? In this article, we will find the answers to all these questions.
What Is A Central Bank Digital Currency?
A Central Bank Digital Currency or CBDC is an attempt to bring some of the reputed benefits of private digital currencies in the area of public money, under the protection of the central banks of the respective nations. This also implies that as per the theory, CBDCs will be secure at the times of financial crisis. So in Central Bank Digital Currency vs cryptocurrency, the basic difference is cryptos like Bitcoins and Ethereum are completely decentralized whereas CBDCs are completely centralized and will be backed up by the central banks of the respective nations.
Comparisons are often done with digital currencies as some of the proposed Central Bank Digital Currency could avail the similar blockchain technology. However, this is not always the scenario. In fact, unlike the blockchain of Bitcoin which is completely decentralized, CBDCs are likely to use a blockchain that can be completely controlled by them. Keeping in mind the recent talks about Central Bank Digital Currency India, let us see how far the idea has been propagated globally.
Types Of CBDC
Usually, there are two kinds of CBDCs – wholesale and retail. Let’s get to know them.
Wholesale CBDCs
These are similar to holding reserves in a central bank. The central bank grants an institution or an account to deposit the funds or use them to settle the interbank transfers. Then the central banks can use the monetary policy tools like the reserve requirements or the interest on the reserve balances for influence lending and set the rates of interest.
Retail CBDCs
The retail CBDCs are the government backed digital currencies that are used by the businesses and consumers. They eliminate the intermediary risk that the private digital currency issuers might become bankrupt and lose the assets of the customers. There exists two types of retail CBDCs and they differ in how the individual users access as well as use their currency.
- The token-based retail CBDCs are accessible with the public or private keys. This validation method permits the users to execute anonymous transactions.
- The account based retail CBDCs require digital identification to access an account.
How Far Have Plans Moved?
While there are few completely deployed and developed CBDCs, several nations have made plans at advanced stages. The e-yuan CBDC of China is among the most advanced digital currencies among big economies. In February 2021, the government offered lunar new year “red packets” that had digital coins to support uptake.
One of the few nations with a completely deployed CBDC is the Bahamas, whose Sand Dollar took off in 2019 and was released properly after one year as an association between the central bank, digital payments platform Island Pay, and payment card group Mastercard.
Other big economies in North America and Europe are still exploring this option. In the case of Central Bank Digital Currency Bank Of England, the story goes this way. In the United Kingdom, the bank of England and Treasury declared a CBDC task force to coordinate studies of a “Britcoin” even though it has not been able to present any findings as of now. In the United States, Federal Reserve chair Jerome Powell asserted in September that the central bank of the US would soon release research on the benefits and costs of deploying a CBDC. Digital currencies have become a highly polarized topic in the US with the same division that is reported among the officials of the Fed on the concept of a public digital currency.
Why Are Governments Of Every Nation Trying To Create Central Bank Digital Currency?
The impulse for Central Bank Digital Currency in the western nations has gained inspiration at least in some parts by two powerful challenges – the primary driven by fear over private entities surpassing the powers of the regulators and the second concern arising from the geopolitical issue.
Stablecoins backed up by the US Dollars have witnessed huge uptakes over the last few years. The coin’s nominal value that is in circulation has increased from less than $30 billion to nearly $140 billion. While much of that amount is kept within the digital currency space, there are evolving attempts to employ stablecoins for cheap, quick transfer.
Novi, which is the digital wallet from Meta which was previously known as Facebook, is giving a trial to the pax dollar stablecoin for transfers that include remittances in Guatemala and also in some parts of the US.
Regulators have pointed out concerns about the private stablecoins on several grounds, including the problems that they might pose to financial stability and also the effectiveness of monetary policy along with consumer welfare. Some also think that an efficient CBDC may decrease the desire of the consumer to depend on stablecoins or at least offer higher protection for retailers. If you are wondering how to invest in Central Bank Digital Currency, it is similar to investing in any other digital currency.
Concerns also arise regarding the e-yuan project of China, which is among the most advanced initiatives of CBDC. Beijing emphasizes in expanding the system ahead of the Beijing Winter Olympics in February. The US critics have voiced fears that its deployment would enable the Chinese government to block shoppers from employing the coin at the stores that fell foul of their own policies and also enable mass surveillance.
How Is Digital Currency Different From Cryptocurrencies?
Earlier it was unknown how the own virtual currency of India will shape up. The new budget has shed some light on the same and confirms the use of Blockchain and other technologies for its use in the country. While earlier this was considered to be the difference between the digital rupee and the other cryptocurrencies, there remains very little to differentiate between CBDC and cryptocurrencies.
1. Currency Management
The primary difference between the CBDC and the cryptocurrencies is that the cryptocurrencies are managed by a computer algorithm while the digital currencies are backed by an authority. The CBDC exhibits properties that are similar to the other currencies, however, they do not have any physical form similar to the coins and the bank notes.You can transfer, receive and/or exchange the digital currency for another currency. It can also be utilized to pay for the goods and services in an online store.
While considering the digital currency, the issuing authority is of the chief importance. It usually refers to the electronic form of the fiat money that is issued by the governments. To be precise, a deputy governor stated:
“A CBDC is the legal tender issued by a central bank in a digital form. It is the same as a fiat currency and is exchangeable one-to-one with the fiat currency. CBDC is a digital or virtual currency but it is not comparable to the private virtual currencies that have mushroomed over the last decade. Private virtual currencies sit at substantial odds to the historical concept of money.”
The digital currency will be backed by the government having seigniorage adding to the sovereign. A seigniorage is referred to as the difference between the value of the currency and the cost of printing it. Thus, the government will earn higher seigniorage in a CBDC as the transaction cost (as opposed to the printing of notes and coins) is much lower.
“Essentially, the simplest example of Digital Currencies is CBDCs or Central Bank Digital Currency, which aims to ease and facilitate transactions across borders. Unlike cryptocurrencies, digital currency does not require encryption, and users are required to use secure and unique passwords in order to protect their digital wallets from hacking or theft”, mentions a blockchain writer.
2. Fluctuations
As the cryptocurrencies such as Bitcoin (BTC) are not managed by any authority such as the US Federal Reserve in the US, the price of the currency fluctuates drastically and there is a wildly swing in the value. The value turns wildly depending on how many people are eagerly buying that specific cryptocurrency. There is no stability in the value of these cryptocurrencies. However, this opposes the principles of CBDC. CBDC aims to protect people from price volatility.
3. Encryption
Anyone possessing an online bank account can preserve and use the digital currencies. It is a form of e-cash. Considering the cryptocurrencies, the underlying technology is blockchain that stores the virtual currency in the “wallets” having a high degree of cybersecurity. In order to trade cryptocurrency, you would first need to have a bank account and cryptocurrency in it. You will also have to exchange the digital currency via an online exchange in order to receive the cryptocurrency for the corresponding value.
A research center in this regard stated,
Digital currency is an electronic representation of currency notes and coins that can be kept in a digital wallet. If necessary, the digital currency can be converted into cash in hand by withdrawing cash from any ATM or bank. It is intangible cash with a two-party open-source contactless transaction flow… When we pay for a product or services with our bank account or digital wallet then we are using digital currency. When we withdraw cash from an ATM the digital currency is converted into physical cash. Cryptocurrencies, on the other hand, are a form of value storage that is protected by encryption. These are created with cutting-edge blockchain technology. It is built with advanced blockchain technology to ensure a smooth transaction flow. They are also known as digital coins. Bitcoin, Ether, and Dogecoin are just a few examples of digital coins. All of these crypto coins are privately owned or created, and most countries have not yet regulated them.”
4. Transparency
The transactions for the digital currency are solely available to the sender, receiver and the banking authorities. Furthermore, the central bank or the issuing authority decides what information can exactly be shared. But all the cryptocurrency details for the transactions are in the public domain and can also be accessed on the blockchain.
5. Transaction Fee
There is a transaction fee with the digital currency everytime there occurs a payment via the digital wallets. However, there is no fee for transacting cryptocurrencies. The blockchain technology aids in the reduction of the expense as well as there is no extra commission for the third party agents. An individual stated,
“Transfers via cryptocurrency are more viable when doing inter country remittances. Crypto can also be used to do large payments, which is usually limited while using digital currencies.”
Risks Associated With CBDC: The Bottom Line
Let us find out about the Central Bank Digital Currency and the future of monetary policy. One big risk around CBDC is the high impact on the traditional retail banks. If the users get access to the liquid cash that is completely backed by the central banks of the respective nations, CBDCs can become a safe passage in the time of financial instability. This will result in taking away all the cash from the bank and leading to a bank run. While this is a benefit of Central Bank Digital Currency, this is again a disadvantage for the traditional banks.
In a similar line of concern, around the control of e-yuan by Beijing, there are debates revolving around the ethics of “programmable money”. If a central bank of a nation has the ability to competently control the spendings of the consumer, this could potentially weaken the fundamental rights and also the free choice.
Finally, there is an enduring concern over financial incorporation that has only evolved during the pandemic, as attempts to record money have been boosted. The Central Bank Digital Currency may be beyond the attainment of those with older devices or those without access to digital wallets, needing the care to dodge further denial of the old and vulnerable.
Frequently Asked Questions On Central Bank Digital Currency
1. Are central bank digital currencies Cryptocurrencies?
Comparisons are often done with digital currencies as some of the proposed Central Bank Digital Currency could avail the similar blockchain technology. However, this is not always the scenario. In fact, unlike the blockchain of Bitcoin which is completely decentralized, CBDCs are likely to use a blockchain that can be completely controlled by them.
2. What is the purpose of central bank digital currency?
A Central Bank Digital Currency or CBDC is an attempt to bring some of the reputed benefits of private digital currencies in the area of public money, under the protection of the central banks of the respective nations. This also implies that as per the theory, CBDCs will be secure at times of financial crisis.
3. Will digital currency replace paper money?
One big risk around CBDC is the high impact on the traditional retail banks. If the users get access to the liquid cash that is completely backed by the central banks of the respective nations, CBDCs can become a safe passage in the time of financial instability. This will result in taking away all the cash from the bank and leading to a bank run.
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