Introduction:

Among the most recent topics in the financial industry are central bank digital currencies (CBDCs). Banks, institutions, and governments are investigating a new form of digital money as an economic and technical innovation. These institutions are preoccupied with CBDCs, which begs the question: why?

Here, we will discuss what CBDCs are, why they matter in digital economies, which countries are exploring their use cases, and how they can be widespread.

Central Bank Digital Currency) CBDCs explained:

CDBC (Central Bank Digital Currency), is a national digital currency or digital form of fiat currency of a country.
CDBC exists purely in electronic form ( & does not have a physical or tangible form, such as a rupee or a coin, and is accounted for or transferred using online systems).

It is the digital representation of the legal currency used by the countries (by the Central Banks of the countries). In short, CBDC is a new form of money created by a country’s central bank, intended to be served in digital form and legally

Central banks are considering issuing digital currencies, or central bank digital currencies (CBDCs), to transform how money is created and managed.

CBDCs would remove the need for central banks to print paper money and replace it with digital money.

CBDCs can potentially transform the practice of monetary policy, making lending more flexible by providing a new tool that makes it clearer to do what’s necessary to foster aggregate demand.

CBDCs are also less risky than physical cash because they are not tangible. A CBDC represents virtual currency issued by the central bank, which is available to citizens for digital transactions and storing value. So, unlike physical cash, no one can ‘steal’ CBDC.

CBDCs are recognized by governments as legal tender within the jurisdiction of the central bank that issued them. This means they can be used for payment by anyone, and merchants must accept them.

Why are countries increasingly interested in issuing their own digital money?

Many central banks are still using outdated technology to process payments. We are now living in a connected global world, where transactions are happening 24/7.

CBDCs are a way to modernize payment infrastructure by enabling faster transactions through more convenient time windows, giving governments and businesses the opportunity to make real-time payments.

Also, in some cases, the cost of managing physical cash is as much as 1% of a country’s GDP. With a CBDC, you can do away with the inefficiencies of printing and moving money.

Difference between cryptocurrencies & CBDC

The underlying cryptography in CBDCs is the same as that used in cryptocurrencies, and the same distributed ledger technology drives them as cryptocurrencies.

Though both cryptocurrencies (like bitcoin) & CDBC, work with underlying DLT (distributed ledger technology), these are the key difference between these.

1. Blockchain networks such as Bitcoin/ Ethereum are a confirmation-free network structure, where participants can access and record transactions at any time.

This structure is not created by a person/group/ institution and is not subject to central management and therefore is not controlled.

CBDCs, on the other hand, are expected to be developed and are under supervision since they are established by the central bank of the country in which they are located.

2. Although CBDC is connected to the blockchain network such as Bitcoin, Ethereum, it is a formation that requires permission. That means, only authorized persons and entities can enter and make changes.

So, unlike crypto money, in CBDC, authorized person can block transactions that are not deemed appropriate, freeze or block the account.

3. While cryptocurrencies (like bitcoin…) do not have a reserve to support their value. But in case of CBDC, there will be gold and foreign exchange reserves underlying.

What are the pros and cons of CBDCs?

Among global financial institutions, the use of central bank digital currencies (CBDCs) is increasing due to the rising popularity of blockchain technology and cryptocurrency. Assuming CBDCs are implemented correctly, the financial system can benefit from the following:

Benefits

1. Analyzing all transactions flowing through the central bank and monitoring in real-time.
2. CBDC reduces the cost of currency management like currency print, minting of coins, transportation of currency, safe custody of currency and tracking of currency etc.
3. By using mobile applications, transactions can be made faster and easier. it promotes an efficient way of financial transaction. This will help in increasing ‘Financial Inclusion’.
4. Note that, as of now also, central banks do already issue a form of digital money but only to banks, which then lend that money to consumers and businesses.

When people currently make payments or move money, it usually goes through a patchwork of systems, often incurring fees for the parties involved and taking a couple days for transfers to be completed.

CBDC could potentially cut out the middlemen, lowering or eliminating fees and making transfers faster.

 

 

 

 

Drawbacks

 

1. Trust issue:

Increasing digitalization may leave some people behind due to ongoing issues regarding trust and data privacy, digital knowledge, and technology access.

2. Hacking risks:

Cyberattacks on a general-purpose CBDC system are more likely to occur due to the fact that the number of endpoints is becoming larger than that in wholesale central bank systems.

 

3. No Boundaries:

CBDCs are able to provide international transfers regardless of work hours, holidays, or time zones. Cross-border payments however face significant barriers due to different legal and regulatory frameworks.

 

Types of CBDCs

There are two types of CBDCs.

1. Wholesale CBDCs

Central banks offer wholesale CBDCs as a service to financial institutions that hold reserve deposits. In addition to improving payment and settlement processes, wholesale central banks can use digital currencies to help.

With a restricted-access digital token, the wholesale CBDC would replace or supplement central bank reserves. As a bearer asset, a token would be transferred directly from the sender to the receiver, so there would be no intermediary in the transaction.

2. Retail CBDCs

A digital currency associated with the central bank aims to cater to the general public.

Based on distributed ledger technology, CBDCs based on retail generally provide features of anonymity, traceability, and availability. As well as offering the possibility of applying for interest rates, they can also offer other services. Central banks located in emerging economies are especially renowned for their retail CBDCs.

 

Conclusion

Central banks are dedicating a considerable amount of attention to the development of digital currencies, so we can expect them to become a reality shortly.

As CBDCs are introduced globally, people will gain access to legal tender platforms that will allow them to convert cryptocurrencies into legal tenders. Also, in the future, CBDCs will impact the way digital assets and securities are bought and sold, including the purchasing and trading of digital assets. But when will this happen?

Global governments will be able to issue a digital form of money based on the foundations of a dedicated legal framework. When central banks and regulators enact concrete policies to establish CBDCs, digital currencies will make their way into the mainstream.