In recent years, the world has moved towards the adoption of digital currencies and as a result of this, Central Bank Digital Currency (CBDC) has become a major topic of discussion in financial circles and also among world governments. CBDC is considered as one of the most important innovations in monetary systems in recent years and is viewed as an opportunity as well as a challenge for central banks.
This article will walk you through what a CBDC is, how it works and its types.
Understanding What A Central Bank Digital Currency Is
A central bank digital currency is a digital currency issued by a country's central bank and serves as a legal tender, much like the traditional paper currency. In contrast with decentralised cryptocurrencies like Bitcoin and Ethereum, which operate independent of any central authority, CBDCs are backed by national governments and central banks.
The idea is to offer a digital alternative to printed cash and leverage the stability and trust associated with fiat currencies in order to provide the convenience and efficiency of digital banks.
Basically, CBDCs are a digital form of a country's currency and they're used within the domestic financial system. They offer the same level of security and stability as physical cash with only the difference being that they're digital. While CBDCs have not reached the level of worldwide adoption, many countries are developing them while some have implemented them. With more countries looking for ways to transition into digital currencies, it is only a matter of time before CBDCs achieve worldwide adoption.
How CBDCs Work
CBDCs operate on a secure digital platform powered by blockchain tech. However, unlike other regular crypto assets, central banks have control over the issuance, distribution and management of CBDCs.
CBDCs can be acquired through digital wallets provided by commercial banks or directly from central banks, depending on the implementation model. All transactions made with CBDCs are recorded on a secure ledger to ensure that they are transparent and traceable. The central bank is allowed to determine where and when CBDCs can be used, meaning that their use can be restricted to certain sectors or conditions.
Types of Central Bank Digital Currencies
There are two types of CBDCs namely, wholesale and retail CBDCs and they are used differently. Wholesale CBDCs are used by financial institutions while retail CBDCs are used by consumers and businesses.
● Retail CBDC: Retail CBDCs are designed for general use by the public and they're available to both businesses and individuals for day to day transactions. They're the digital equivalent of cash and they can be used to purchase goods and services. The main aim of retail CBDCs is to provide more security by eliminating the risks associated with private digital currency issuers and providing a more reliable payment method.
● Wholesale CBDCs: This type of CBDC is used exclusively by financial institutions and other large entities that make huge transactions. It is similar to holding reserves in the central bank. They're designed to make interbank transfers better and improve payment settlements.
Potential Benefits of CBDCs
● CBDCs can modernize payment infrastructure by making them faster, cheaper and more efficient across domestic and cross-border lines.
● They mitigate potential risks associated with intermediaries like banks in case of events like bankruptcy or bank runs.
● Cross-border transactions are usually slow and expensive due to intermediaries and regulatory issues, but CBDCs eliminate this by reducing these complex distribution systems, thereby reducing costs.
● CBDCs can create a direct link between central banks and individuals, thereby removing the costs for implementing financial structure and making finances more accessible to those without access to banking facilities.
Challenges of CBDCs
● Since CBDCs are issued by the central bank, it's inevitable that the government may intrude in order to keep track of financial crimes such as money laundering and terrorism funding. Privacy is a key feature of cryptocurrencies, but with the government snooping around, CBDCs raise privacy concerns.
● CBDCs pose a big threat to traditional finance systems because it reduces the need for traditional banks and it is unknown how this could affect a country's economy or the financial sector in the long run.
● Cyber attacks have been a consistent theme in cryptocurrency and with a digital currency issued by the central bank, you can only expect the same trend to continue.
● CBDCs are just digital fiats which means the same concerns of government printing will still not be addressed.
Conclusion
Several countries are making efforts to develop Central bank digital currencies while others are making research to ensure its adoption in the nearest future. Countries like the Bahamas, Nigeria and Jamaica have functioning CBDCs and the world is expected to follow suit soon. Nonetheless, it’s still in development and has several hurdles to scale.
Comments