The concept of money and spending has been evolving dramatically since the advent of cryptocurrencies. Notably, digital currencies have continued to garner interest while exposing the world to possibilities it never imagined were even conceivable.
Interestingly, owing to its entirely decentralized system, cryptocurrency became a honeypot for many, so much so that it has since drawn the attention of governments worldwide. Today, governments and institutions worldwide are forging another path of using digital currencies through Central Bank Digital Currency (CBDC).
A CBDC, which is issued and regulated by the central bank, is basically the digital variation of a country’s fiat currency. You can think of it as Bitcoin (BTC) or Ethereum (ETH), albeit issued and backed by a nation’s central bank.
In recent years, various governments have been exploring CBDCs for their advantages, such as increasing efficiency in payments, lowering transaction costs, and promoting financial inclusion by providing easy and safer access to money for unbanked and underbanked populations.
This enthusiasm is further backed by Atlantic Council, a website that tracks the implementation of CBDC worldwide, which revealed that at least 105 nations, accounting for more than 95% of the world’s GDP, are exploring a CBDC. This stands in stark contrast to the mere 35 countries that were reported in May 2020.
In this piece, we’ll unravel everything there is to know about CDBCs, including what they are and what makes them different from a typical cryptocurrency.
What Is CBDC?
A Central Bank Digital Currency, known as CBDC, is a digital currency similar to cryptocurrency but one that is issued and regulated by a central bank. This digital currency is issued in token form or with an electronic record associated with the currency and pegged to the domestic currency of the issuing country or region.
Since central banks issue digital currency, they maintain full control over the CBDC. So $10 of a US digital currency would always be worth the same as a $10 note; the same is also applicable across other countries’ CBDCs. Moreso, the government-backed issued digital currency has utility similar to physical currencies and can be used to purchase goods and pay for services.
According to the International Monetary Fund (IMF), centralized technology such as CBDCs can reduce expenses, facilitate seamless money flow, improve financial inclusion, and provide safer access to money through digital channels.
A CBDC can also be recognized as a legal tender; for example, Jamaica became the first country to do so in June 2022. Its digital currency, Jam-Dex, can be used to pay for goods and services.
Advantages and Disadvantages of CBDCs
CBDCs offer many great advantages and some potential disadvantages. But first, let’s look at the advantages:
1. CBDCs allow real-time monitoring and analytics of all the finances running through the central bank.
2. They enhance the efficiency of central banking systems and reduce criminal activity.
3. They enable faster and easier transactions via mobile applications, and potentially reduce net transaction costs, benefitting lower-income households.
4. They reduce costs of financial services by limiting the printing of banknotes and eliminating physical cash distribution and destruction from circulation.
5. The general population can more broadly accept CBDCs because they are subject to legal and government regulations.
6. CBDCs ensure better privacy levels. They can provide the assurance of better anonymity compared to the current commercial bank card payments.
Some Disadvantages Include:
1. The World Economic Forum has warned that digital money’s risks from counterfeiting, theft, and network failure could have more catastrophic consequences than cash.
2. CBDCs could result in less privacy, as there is a loss of ability to transact anonymously. A country’s central bank would have full control over its CBDC. The central bank could, theoretically, decide to put restrictions on the types of transactions it allows.
3. CBDCs have prominent geographic restrictions as they are accepted only in the country that issues them.
4. If consumers have access to retail CBDCs, commercial banks could lose a huge portion of their business. This would be terrible for banks and could also impact the stock market since bank stocks could drop in value.
5. CBDCs can also increase the risks of system-wide bank runs. Such types of bank runs could increase faster in times of financial crisis without any dependence on time and proximity.
What Are the Types of CBDC?
Now that we have established the meaning of CBDCs, let’s dive into the various types. Particularly, there are two types of CBDCs – wholesale and retail. So what are the key differences?
1. Wholesale CBDCs
Wholesale CBDCs are used by financial institutions such as banks. The use of CBDCs would allow banks to make payments in a quicker and more automated manner. Cross-border transactions may become faster and more reliable.
2. Retail CBDCs
Retail CBDCs, on the other hand, are used by individuals. People could use them essentially as digital cash, with the comfort of knowing that the currency is issued and backed by the country’s central bank. In addition, retail CBDCs come in two categories, both of which differ in terms of accessibility and utility cases:
- Token-based retail CBDCs: These are accessible with private/public keys. This method of validation allows users to execute transactions anonymously.
- Account-based retail CBDCs: These require digital identification to access an account.
Implementation of CBDCs Across Various Countries
105 countries, representing over 95% of global GDP, are exploring a CBDC. In May 2020, only 35 countries were considering a CBDC. A new high of 50 countries is in an advanced exploration phase (development, pilot, or launch). However, here’s a randomly selected list of countries that have launched CBDCs:
Bahamas: The Central Bank of the Bahamas issued the Sand Dollar in October 2020, making it the first nationwide CBDC in the world.
Before the nationwide issuance, the Sand Dollar pilot program was launched in December 2019 on The Exumas. The project is intended to drive greater financial inclusion and provide wider access to financial services across the sparsely populated archipelago, consisting of 700 scattered islands.
Nigeria: Africa’s largest economy, Nigeria became the first country in Africa to launch a CBDC in October 2021. The eNaira is stored in a digital wallet and can be used for contactless in-store payments and for transferring money. By the end of January 2021, the eNaira wallet had received almost 700,000 downloads.
The Nigerian president, Muhammadu Buhari, said it could potentially boost Nigeria’s Gross Domestic Product by up to $29 billion over the next decade. The eNaira will be a CBDC, issued by the government, and it will have the same value as the paper, or fiat, currency.
Eastern Caribbean Currency Union: Seven Eastern Caribbean Union countries developed their own digital currency to help speed up transactions and serve the unbanked. The seven countries are Antigua and Barbuda, Dominica, Grenada, Montserrat, St. Kitts & Nevis, Saint Lucia & Vincent, and the Grenadines.
The Eastern Caribbean Central Bank said “DCash” is the first blockchain-based currency introduced by any of the world’s currency unions, although few individual nations have similar existing systems.
China: Asia’s largest country, China, became the world’s first major economy to pilot a digital currency in April 2020. The People’s Bank of China aims for widespread domestic use of the e-CNY or digital yuan. This year, there was a trial launch at the 2022 Winter Olympics. In September 2022, the country said it would extend the trial of its e-CNY digital currency to four major provinces, including Guangdong, the most populous province.
Sweden: The e-krona, Sweden’s digital currency, has been undertaking a series of tests for retail and international remittance payments. Specifically, the Swedish central bank concluded the second phase of its CBDC test in April 2022 and is currently undergoing its final round of tests before it finally goes public. While tests are still ongoing, Sweden’s Riksbank is said to have developed a proof of concept and is presently exploring the technological and regulatory implications of CBDC.
Europe: The Governing Council of the European Central Bank (ECB) launched the investigation phase of a digital euro project in 2021. The investigation phase will last 24 months and aim to address key issues regarding design and distribution.
CBDC vs. Cryptocurrency: What’s the Difference?
Now, you could be confused about how CBDC differs from cryptocurrency and vice versa. Here’s how:
CBDCs are digital versions of government-backed fiat money that use blockchain technology to verify and store transaction data. However, the major difference between CBDC and crypto is that the former operates on a centralized, permissioned network. A central bank oversees and facilitates the transactions with the help of other third-party organizations with CBDCs.
On the other hand, cryptocurrencies are stored on a decentralized blockchain network, where transactions can happen, be authenticated, and be recorded in the public ledger without any third-party interference or central authority monitoring the activities. Simply put, there is no central decision-maker. Bitcoin, as an example, can be transacted anonymously in peer-to-peer exchanges, whereas CBDCs transaction lacks anonymity.
Why You Should Care
CBDCs will ultimately revolutionize how people utilize money and the world’s economic system at large. Notably, CBDCs will open up, among other things, new possibilities like borderless payment while heralding new advantages, including improved security, faster settlements, ease of use, low transaction costs, and instant implementation. In all of this, the governments and institutions must also be willing to promptly address its rising challenges.
Find out more about the recently held G20 Techsprint CBDC challenge:
Dragonfly Fintech Wins G20 TechSprint CBDC Challenge
Read more on Australia’s CBDC project:
Ex-Ripple Executive to Lead Australia’s CBDC Project