Bearing similarities with crypto coins, CBDCs stand for Central Bank Digital Currency and are essentially, digital tokens. However, these digital tokens are issued by the country’s central bank and have the same value as their fiat currency. Additionally, understanding what CBDCs are is important as many countries are switching over to digital currencies. For instance, countries like China have gone ahead and implemented CBDCs into their financial systems.
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Basically, what CBDCs aim to achieve is to provide consumers and businesses with convenience as well as financial security. With CBDCs, the government will spend less on maintaining complex financial systems. Also, in a bid to reduce the financial stress of using volatile digital currencies, CBDCs provide a stable form of exchange.
Wondering what CBDCs are and how they work? Keep reading to discover the amazing features of CBDCs and how they differ from stable coins. Also, further into the article, we discuss different countries that use CBDCs as well as their pros and cons.
What are CBDCs and How Do They Work?
Although CBDCs are digital, they have a unique technological makeup. CBDC, which is an acronym for Central Bank Digital Currency, is a digital currency that’s backed and controlled by the government. Additionally, CBDCs can also be referred to as the virtual or digital form of fiat currencies such as USD, GBP, or EUR. Interestingly, many countries are exploring CBDCs to digitalise their financial systems.
Furthermore, CBDCs simplify how fiscal and monetary policy are implemented. Also, they promote the financial inclusion of fiscal policy. Although CBDCs are digital currencies, unlike cryptocurrencies, they aren’t decentralised. Owing to their centralisation, CBDCs don’t offer anonymity in transactions like crypto.
CBDCs are considered legal tender used in the exchange of goods and services just like coins and banknotes. Thanks to the world going digital, physical fiat currencies are slowly giving way to digital methods of payment. For instance, physical currency birthed credit-based transactions that became total lifesavers during the COVID-19 pandemic. People were able to carry out contactless deliveries and purchases using digital payment methods.
According to the Federal Reserve System in the United States, over seven million people do not use commercial banks. This figure represents about 5% of the households in the United States. Likewise, about 20% of people in the U.S. use payday loans but do not have bank accounts.
For countries that are seeking to go cashless, CBDCs are an ideal alternative. However, many governments are pressured to adopt CBDC due to the rise of private e-money. Governments that issue CBDCs are likely to have an edge over private e-money.
The way CBDCs work is likely to differ from country to country. However, not all CBDCs follow a typical model. With CBDCs, you don’t need to wait for several business days before your transaction is successful. Also, it doesn’t pass through multiple banks before money can be sent, unlike fiat currency. One advantage of CBDCs is that consumers that do not have bank accounts can use CBDCs.
Features of CBDCs
Because CBDCs are quite recent, many people are quite unsure of their features. One interesting feature of CBDCs is that, just like cash, they are peer-to-peer. However, it has some other features that distinguish it from cash. These features are
They can be restricted or universal
DLTs, which is known as Distributed Ledger Technologies, is bitcoin’s underlying technology. DLTs will help financial institutions to keep track of the transactions a person has made or how much they have. In other words, DLTs aid in financial record keeping as their transaction history is stored in a ledger.
One good thing about DLTs is that they have several copies of people’s transaction histories. These copies are managed and stored by another financial institution. However, the financial institutions are controlled by the country’s central bank. Additionally, how all the financial institutions share DLT is distributed in nature.
Furthermore, the distributed manner of sharing DLTs is referred to as “permissioned blockchain.” In a permissioned blockchain, only authorised entities can alter or access the blockchain. Likewise, the authorised entities control what people with access to the blockchain can do with it.
CBDCs reduce transfer costs
Thanks to the structure of CBDCs, transferring money isn’t as expensive as transferring cash. CBDCs make financial entities more connected resulting in an easier way of transferring money from one person to another.
CBDCs are centralised
As we stated earlier, CBDCs use a permissioned blockchain. One feature of CBDCs that sets them apart from crypto coins is that they are centralised. For instance, Ethereum and Bitcoin are decentralised, meaning they are not controlled by any entity or group of entities. There’s no way a government of a country will not want some sort of control over aspects of their legal tender.
Furthermore, DLT technology allows the government to have control over the financial entities that manage the ledger. Another aspect the government controls is the supply of CBDCs. They also decide when to add or remove items from the supply.
With CBDCs, payments are tracked
Thanks to DLTs, keeping a record of customers’ transactions is easy. Should the U.S government adopt CBDCs, they intend to use the financial information to secure the privacy of their citizens. However, China is likely to use the financial information DLT provides to keep a close eye on its citizens.
Types of CBDCs
There are different types of CBDCs. The first model of CBDCs is known as “retail CBDC” and the second is “wholesale CBDC.” Here is a detailed overview of these two types of CBDCs.
Wholesale CBDC
This type of CBDC aims at settling transactions between financial entities as well as facilitating payments. What wholesale CBDCs do is manage risks and ensure transaction settlements are efficient. In addition, wholesale CBDC can be used for asset transfer of securities.
There are two types of wholesale CBDC that are categorised according to how they are implemented. They are:
Cross-border payment wholesale CBDC
Domestic payment wholesale CBDCs
As far as cross-border transactions are concerned, they rely on several intermediaries as well as jurisdictions for single payments. Wholesales CBDCs can be used in three scenarios to remedy cross-border transactions. The scenarios can be either
Local transferable wholesale CBDCs
Local wholesale CBDCs
Universal wholesale CBDCs
Furthermore, wholesale CBDCs can be used for secure payments. Any CBDC that is used for secure payments is capable of supporting the digital transformation and tokenization of the value chain security.
Retail CBDC
Retail CBDC makes use of many payment tools and does so flexibly. It aims to ensure successful payments between individuals and businesses. Additionally, this model of CBDC is available to the public in deposit accounts with the central bank. Likewise, it is available in tokens that are digitally issued.
Digitally issued tokens represent a digital alternative to banknotes and coins. Likewise, with deposit accounts, customers can easily receive and initiate transactions as well as check their balance. Additionally, the advantages of having an account with commercial banks are not lost with retail CBDC.
Furthermore, there are three types of retail CBDC. They include
Direct retail CBDC – It focuses on individuals and businesses that own CBDCs by taking advantage of private accounts in the central bank.
Indirect retail CBDC – It requires a financial institution intermediary to set up indirect retail CBDCs.
Hybrid retail CBDC – It is a blend of direct and indirect retail CBDC.
Countries That Use CBDCs
According to the Atlantic Council, 87 countries are on the verge of having their own CBDC. The figure moved from 35 countries that were considering CBDC in May 2020 to 87 due to the COVID-19 pandemic. Interestingly, these 81 countries serve as a representation of the world’s GDP.
The latest country to launch its CBDC is Nigeria, with the e-naira, making it the first country in Africa and outside the Caribbean. Other countries, like China and the Bahamas, have their own digital currencies, with countries like South Korea and Canada considering launching theirs. Some notable countries that use CBDC include:
Sweden E-Krona
The European Union’s “The Digital Euro”
The Marshall Islands “Marshallese Sovereign”
The Bahamas’ “Sand Dollar”
China “Digital Currency/Electronic Payment”
Furthermore, the UAE which is fast becoming a global crypto hub, has unveiled plans to launch its first ever digital currency by 2026, as disclosed by the central bank of the oil-rich Gulf state, which serves as the region’s financial hub.
CBDCs Pros and Cons
One of the drawbacks of CBDCs is that they don’t offer as much privacy as cryptocurrencies. However, it is safer than commercial banks as it has no risk of collapse. Here are some pros and cons of CBDCs.
Pros
CBDC payments are more secure and efficient
They are easy to track allowing the government easily detect illicit activities and fraud
They enable customers to interact directly with the central bank
CBDCs have reduced risk of collapse unlike commercial banks
Cons
They aren’t private as the government still has access to the transaction record
They allow for competition between commercial and central banks
CBDCs may not be widely adopted by people as some don’t particularly trust digital currencies
Central banks are in absolute control of CBDCs
What Are Stablecoins?
Typically, Stablecoins are cryptocurrencies that have their value hinged on another asset, such as gold or fiat currency. The asset is used to stabilise the price of the stable coin. Although crypto coins like Ethereum and Bitcoin provide several benefits, one downside is their volatility. The prices of crypto coins are often unpredictable and fluctuate rather wildly.
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In contrast to fiat currency or assets that experience stability, crypto coins are unstable. What Stablecoins do is that by pegging the price value of cryptocurrencies to stable assets, price fluctuations are remedied. Additionally, there are a variety of asset types that collateralised Stablecoins use as backing. They are,
Cryptocurrencies
Fiat currencies
Precious stones like silver or gold
Other investments
Furthermore, there are some common stable coins such as Tether, Diem, USD coin, and Dai. One drawback of Stablecoins is that a reserve backing Stablecoins may be unable to redeem all the units of stable coins. Also, it’s important that you view Stablecoins with an open mind as cryptocurrency can be quite risky.
Differences between CBDCs and Stablecoins
One similarity between CBDCs and Stablecoins is their technological makeup. Like Stablecoins, CBDCs also depend on blockchain technology to function. However, there are significant differences between both terms that distinguish them. Some of these differences include,
CBDCs are controlled by the country’s central bank. For instance, China’s CBDC is solely controlled by the People’s Bank of China. On the other hand, Stablecoins are controlled either by the developer alone or by coin owners and miners.
Stablecoins value are determined by other assets. For example, a stablecoin may be backed by stocks or precious metals. While CBDCs get their value from the country’s fiat currency value. In the case of the Bahamas’ Sand Dollar, if the value of their fiat currency drops, the value of their CBDC will plummet.
CBDCs don’t offer pseudonymity as cryptocurrencies do. Government officials have access to a person’s information because they created the CBDC. Stablecoins on the other hand, in a way, function like cryptocurrencies. However, there is a possibility that those maintaining the stablecoin may have access to the holder’s information.
The utility of Stablecoins is restricted. The sole purpose of Stablecoins is to facilitate trades between multiple cryptocurrencies. On the flip side, CBDCs are meant to replace fiat currency. Because the CBDC is seen as a legal tender in the country, citizens can use it for transactions as they would banknotes and coins.
In Conclusion
There’s no doubt that the world is undergoing a digital revolution and the financial industry isn’t left out. With China leading the pack, other countries have launched and are heavily considering launching their CBDCs.
Although the adoption of CBDCs by citizens is a major concern, CBDCs is a more efficient alternative to fiat currency. Additionally, with CBDCs, the government can cut down costs of maintaining a complex financial system.
Although CBDCs are still in the formative stage, they’re gaining fame across different countries in the world. As the number of countries launching their CBDC keeps growing, there’s a possibility that fiat currency will be replaced by CBDCs.