Understanding the Essence of Central Bank Digital Currencies (CBDCs)

The Rise of Central Bank-issued Digital Currencies (CBDCs)

The use of digital assets has become increasingly prevalent in today’s society and financial system. Recognizing the advantages of technological advancements, financial institutions have started exploring ways to incorporate the technology behind digital assets into the existing economic system. As a result, the emergence of privately issued currencies has prompted central banks worldwide to investigate the possibility of issuing their own central bank-issued digital currency (CBDC).

Crypto Daily is committed to providing valuable information to its readers and aims to demystify CBDCs. In a series of comprehensive articles, we will explore all aspects of CBDCs to ensure our readers understand this emerging technology as we transition into a cashless society.

This introductory article will discuss what CBDCs are and touch on the two categories they fall into. We will also explore the benefits of CBDCs.

What Are CBDCs?

To understand central bank digital currencies (CBDCs), it is crucial to grasp the concept of digital money. Technological advancements have transformed the forms of money used in society. We have progressed from bartering goods and services, using collectibles as currency, and physical coins and banknotes to digital money stored on computers. Blockchain technology has revolutionized digital money, leading us to explore programmable digital money issued by central banks – CBDCs.

According to the Bank of England, CBDCs are digital forms of money issued by a country’s central bank. They do not exist in physical form like notes and coins but are represented as electronic amounts stored on devices such as computers. IBM describes CBDCs as digital versions of “fiat money that is issued by central banks.” Essentially, CBDCs can be understood as a digital representation of a country’s physical currency.

The Bank for International Settlements (BIS) defines CBDCs as digital currencies issued by central banks but distinct from digital balances used in the traditional central banking system. CBDCs are widely accepted as a medium of exchange and a store of value.

While both crypto assets and CBDCs rely on blockchain technology, they differ significantly. One key difference is that CBDCs are backed by central banks and are considered legal tender. Digital and crypto assets, on the other hand, are privately issued. Additionally, CBDCs operate on secure and transparent blockchain networks, creating immutable records of transactions. This means that transactions recorded on a decentralized ledger cannot be modified or tampered with.

CBDCs offer the same level of security as cash as they are managed by a central bank. In contrast, cryptocurrencies are not controlled by a central authority and are known for their volatility.

The introduction of CBDCs aims to improve payment efficiency and reduce costs associated with physical currency, such as printing, storage, and transportation.

Retail and Wholesale CBDCs

CBDCs can be classified into two categories: retail and wholesale CBDCs.

Retail CBDCs function similarly to cash and are accessible to the general public. They allow people to send and receive money, make payments for goods and services, and receive grants and payments directly from the government. Retail CBDCs are anonymous, traceable, always available, and bear interest. According to Consensys, most central banks agree that retail CBDCs should possess several key features:

CBDCs are a new form of central bank money controlled and issued by the central bank.
Unlike commercial bank money, CBDCs appear as liabilities on the central bank’s balance sheet.
Retail CBDCs are legal tender, accepted as a means of payment, and considered a “safe store of value by all citizens, enterprises, and government agencies.”
CBDCs should be distributed in a 1:1 ratio with the relevant fiat currency issued by the central bank.
Consumers do not need a bank account to use or obtain CBDCs.
Transaction costs should be lower than existing systems.

Wholesale CBDCs, on the other hand, are limited to financial institutions and primarily used for interbank payments. They can serve as an addition to or replacement for real-time gross settlement systems (RTGS). Wholesale CBDCs are not accessible to citizens.

Benefits of CBDCs

CBDCs are being developed for various reasons and offer multiple benefits. They are digital versions of fiat currencies issued and backed by central banks. One of the main advantages is their ability to provide a reliable and secure means of digital payments and remittances. CBDCs can be used for both online and offline transactions and can be integrated into existing payment infrastructure. They also offer an alternative for settling cross-border payments, which can be challenging with fiat money.

In a report by the Official Monetary and Financial Institutions Forum (OMFIF), CBDCs are seen as potential contributors to creating an integrated and interconnected financial system. While developing CBDCs may come with development costs, they offer cost efficiencies that outweigh many drawbacks. Handling physical cash is often associated with high costs and inefficiencies. Retail CBDCs, operating as a 24/7 payment system with instant settlement, can reduce costs by eliminating counterparty risk.

An important benefit of CBDCs is their potential to provide financial inclusion to the unbanked or underbanked populations. In developing countries, traditional banking services may be limited due to a lack of infrastructure and high costs. CBDCs provide an alternative to cash and may make it easier for people to access financial services and participate in economic activities.

What’s Next?

In future articles, we will delve into the differences between privately issued digital assets and CBDCs, explore retail and wholesale CBDCs in more detail, discuss the various designs of CBDCs (token and account-based), examine the implementation of CBDCs in developing versus developed economies, explore the drawbacks of CBDCs, and provide in-depth discussions on where CBDCs are currently being investigated.

Hot Take: The Future of Central Bank Digital Currencies

The rise of central bank-issued digital currencies (CBDCs) marks a significant shift in the financial landscape. As society embraces digital assets and explores programmable money, central banks are taking steps towards issuing their own digital currencies. CBDCs offer benefits such as improved payment efficiency, reduced costs, and increased financial inclusion. They differ from privately issued crypto assets as they are backed by central banks and operate on secure blockchain networks. Retail CBDCs provide a cash-like experience for the general public, while wholesale CBDCs serve financial institutions for interbank payments. The development of CBDCs opens up new possibilities for seamless digital transactions and cross-border payments. As we move towards a cashless society, CBDCs will play a crucial role in shaping the future of money.