Search

Crypto Explained

What Is a CBDC?

November 12, 2021

Christina

An image of a digital bank.
Central bank digital currencies (CBDCs) are now widely regarded as an inevitability for most of us, if not yet already a reality. But what is a CBDC, and how will it affect you?

A recent report published by the Bank of International Settlements claims that CBDCs can reduce the cost of cross-border payments by half and increase the speed of payments from days to mere seconds. 

Moreover, governments around the world are in various stages of research and development of their own CBDCs.

What is a CBDC?

A Central Bank Digital Currency is a digital version of fiat currency. However, although the term CBDC refers to digital currency, a CBDC is quite different from a cryptocurrency like Bitcoin or Ethereum, or even from stablecoins such as Tether or USDC. Cryptocurrencies are based on open, decentralized blockchains. Anyone can join and become a miner or validator, assuming they can procure the prerequisite hardware, minimum stake, or both. 

The rules of the blockchain network, including how new coins are issued, are programmed in and known to network participants and users. For instance, Bitcoin’s issuance is deflationary, thanks to its regular halvings and capped supply of 21 million BTC. Rules like the halvings can only be changed with a vast amount of disruption, requiring consensus from the network and explaining why upgrades are so very rare. 

Although there are very few CBDCs yet, it seems unlikely that many governments will opt to use a public blockchain to issue a national digital currency. China has become among the first to issue a CBDC, but the first iteration of the digital yuan is based on centralized technologies. Although the Chinese central bank has recently indicated it may consider using blockchain, it acknowledges that the limitations are currently too extensive. 

Of course, a core feature that sets fiat currencies of any description apart from crypto is that central banks control the issuance, and a CBDC is no different. 

Types of CBDCs

CBDCs can also take a few different formats. The Chinese digital yuan is designed for use by citizens and banks alike as a virtual replacement for physical cash. 

However, CBDCs can also be used as a cross-border settlement currency between banks without going to the extent of a full rollout to all citizens. This initiative is referred to as a wholesale CBDC, and there are reportedly several countries and institutions involved in pilots. 

For example, in June, Swiss banks UBS and Credit Suisse and French bank Natixis confirmed they were involved in a pilot, along with the Swiss SIX Digital exchange and the Bank of International Settlements (BIS). Fintech firm R3, which operates the Corda permissioned distributed ledger, is also participating. 


[Read Now: Switzerland’s Crypto Valley is Blazing a Trail in Regulated Digital Asset Markets]


The BIS is also spearheading another wholesale CBDC initiative with the Hong Kong Monetary Authority, the Bank of Thailand, the People’s Bank of China, and the Central Bank of the UAE. 

Does the more widespread enthusiasm for wholesale CBDCs mean it’s less likely that we’ll see bills and coins replaced with digital wallets for dollars, euros, or yen? Not necessarily. 

If these intra-banking initiatives are a success, they’ll serve as a blueprint for a broader CBDC rollout by governments. They offer the established financial system an opportunity to experiment and stress-test CBDCs without impacting the average citizen directly. 

Central bank chiefs such as the US Federal Reserve’s Jerome Powell and the head of the European Central Bank Christine Lagarde have offered cautious support for the idea of CBDCs that replace national currencies in their respective jurisdictions. 

Opportunities for adopting CBDCs

Despite their differences from cryptocurrencies, CBDCs offer many of the same benefits. As already mentioned, the BIS believes they can bring significant efficiencies in settlement times and costs. One constraint on the time it takes to settle cross-border payments is that banks only operate during fixed hours, along with the fact that there is no universal definition of the working week. CBDCs would enable near-instant payments and could transact on a 24/7 basis, the same as the crypto markets. 

Cash also costs, and CBDCs could reduce or eliminate the costs of printing money. The US Federal Reserve Board has an operating budget of over $1 billion for printing paper US dollars, with the average $1 bill costing 6.2% of its value to produce. 

Many sources also point to the idea that CBDCs could help promote financial inclusion by leveraging the fact that there are more cell phone owners than people who hold a traditional bank account. Mobile payments initiatives like China’s WePay and Kenya’s MPesa have proven to be popular among users. They can penetrate rural areas and communities out of reach of the banking system and bypass the need for identity documents. 

Risks of CBDCs

CBDCs come with their own set of risks, whether we consider wholesale CBDCs or replacing paper money. When China first launched its digital yuan, it didn’t take long for scammers to begin impersonating government “testers” and duping investors into giving away their fiat currency. Central banks will need to ensure that any digital currency has proven itself robust against hacks and fraud before rolling it out at scale. From this perspective, a decentralized ledger could be a more reliable solution than using centralized servers. 

Perhaps a bigger concern for individual citizens is privacy. A digital footprint of every single transaction would deter some users who don’t want to imagine that the government could trace their every move. As such, central banks will need to strike a careful balance to ensure that appropriate fraud prevention measures don’t act as a blocker for adoption. 

Regardless of the implementation of CBDCs, it seems unlikely that they’ll replace cryptocurrencies or even stablecoins as an asset class. Nevertheless, it seems increasingly probable that CBDCs will become normalized over the coming decades and perhaps even replace paper money permanently. 

Related Articles

How Do DeFi’s Liquidity Pools Work?

November 23, 2021

Christina

Liquidity pools are arguably the most revolutionary of all the innovations in the decentralized finance (DeFi) space. Pioneered by decentralized exchanges such as Uniswap and Bancor, liquidity pools are now a highly competitive segment.

Keep up with crypto through EQONEX!


This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.

What Is a Double-Spend, and How Does Bitcoin Prevent It?

November 16, 2021

Christina

The “double-spend” problem is one of the many pieces of jargon that often seems confusing to anyone unfamiliar with cryptocurrencies because it doesn’t exist in traditional finance. Understanding the double-spend problem and how Bitcoin solves it is key.

Crypto Spot Trading and Customized Leverage on the EQONEX Exchange

November 9, 2021

EQONEX

Spot trading with crypto refers to trading "on the spot," meaning that when you buy or sell crypto assets, the transactions are settled in real-time. Spot trade crypto on the EQONEX Exchange with customized leverage.

How to Trade Perpetuals and Make the Most of EQO-D on EQONEX

October 18, 2021

Ian Fleetham

Ian Fleetham, Head of Trading at EQONEX, shows how to trade Perpetuals on the EQONEX Exchange. Use EQO-D, the first EQO airdrop, and cross-collateral to make the most from your trades.