While the number of countries learning the CBDC concept is actively growing, we invite you to explore the key fundamentals of central bank digital currencies in this guide.
The adoption of cryptocurrency and blockchain technology has gained significant momentum over the past few years, especially in 2020. The COVID-19 pandemic has wreaked havoc on people's traditional financial system and opted for cashless options. The immense popularity of Bitcoin and the emergence of several blockchain-backed projects, such as the announcement of the launch of Facebook Libra last year, has made governments realize the importance of these regulatory free and decentralized financial systems and protect traditional banking and finance from these threats. industry.
Despite being influenced by decentralized cryptocurrencies like Bitcoin, CBDC is more of a reaction than adoption of cryptocurrency, which central banks see more as a threat to fight. These central banks are implementing the stablecoin concept in order to have in-depth knowledge of the cryptocurrency space to develop their version of the digital currency, which will be regulated and managed by the respective monetary authorities or central banks of a particular country.
What is CBDC?
Central Bank Digital Currency (CBDC) is the digital form of a country's fiat money. The present concept of CBDC uses the concept of blockchain and distributed ledger technology such as cryptocurrencies. However, CBDCs are different from virtual currency and cryptocurrencies because the latter is decentralized, meaning they are not issued by the government and do not have the status of legal tender as claimed by the government.
The creation of a CBDC should combine the best of both worlds - the convenience and security of a digital form such as cryptocurrencies, and the regulated, reserved money circulation of the traditional banking system. Each CBDC unit will act as a secure digital equivalent of fiat currency and can be used as a payment method, store of value and unit of account. Because it is a fiat currency with a unique serial number, each CBDC unit will also be different to prevent counterfeiting. Because it will be part of the central bank money supply, it will work alongside other forms of fiat currencies.
There are two main types of CBDCs, wholesale and retail CBDCs, and both have different purposes.
CBDC is a digital currency used in transactions between a central bank and other private banks. It can also be used for cross-border transactions between banks. An example is the Inthanon project − Lion rock, a cross-border digital payment system between the Bank of Thailand and the Central Bank of Hong Kong.
Retail CBDC is the digital money that people will use to transact in their daily lives. Retailing CBDC can make cash obsolete and traceable as well, thus reducing various types of criminal activity.
Benefits of CBDC
The financial system is always dynamic due to new technologies emerging from time to time in this sector and the emergence of digital currency is no different. Some of the benefits of taking CBDC:
- CBDC can improve the performance and security of both retail and wholesale payment solutions. These improvements range from retail vendors using point of sale, online or P2P solutions, to bulk interbank payments with faster settlement options.
- As cryptocurrency leads the world towards cashless settlement, the implementation of CBDC is helping to simplify the transition from fiat currency to digital options by having an anti-illegal activity regulator.
- The introduction of a government-backed digital currency will help make international digital transactions between parties fast and hassle-free.
- In recent years, especially this year, cash flows have dropped significantly as more consumers use cards and applications to settle payments. Let's assume a CBDC is to be issued and recognized as legal tender. In this case, reducing the use of cash can help mitigate some of the negative uses of cash (tax evasion, money laundering, illegal transactions, etc.)
- The implementation of CBDC helps prevent criminal activities such as money laundering, tax evasion or tax evasion, and other activities by tracking and monitoring the movement of money.
Risks associated with digital currencies of the Central Bank
The most frequently cited disadvantage is that commercial banks will refuse intermediaries if consumers begin to switch to CBDC entirely. This can create a vicious circle as banks raise deposit rates to attract more money. In turn, this means fewer bank loans, provided at higher interest rates.
There are also doubts as to whether the CBDC requires the central bank to carry out the KYC / AML processes and other operational burdens that commercial banks typically handle.
There is also the issue of reputational risk, as CBDCs can be subject to cyberattacks, various types of errors and failures that can negatively affect the reputation of the central bank.
While the central bank's digital currency has potential advantages for cross-border transactions, CBDC can nevertheless threaten an economy with high inflation and volatile exchange rate ranges due to the risk of dollarization.
Where is CBDC located today?
Several central banks are exploring the possibility of introducing a digital currency, and most of them are in the research phase and some are still in the planning stage. The achievements of the central banks of some countries are listed below:
China
An Asian country with a population of more than 1 billion people is a suitable testing ground for the introduction of cryptocurrency; China is arguably the leading country in the adoption of digital currency. The project to develop a new digital currency started at the beginning of this year. It is now reported to have passed its first test phase, with 1,1 billion yuan ($162 million) processed from April to August under 3,1 million yuan digital transactions, making CBDC the most widely used commercially.
Sweden
The country has long been interested in CBDC and was one of the first testers of the introduction of digital currency. At the beginning of this year, the launch of the annual pilot project of its proposed digital currency, the electronic krone, began. The Swedish government believes that in 2023 the transition to digital currency will be successful, and retailers will start using it for transactions.
Uruguay
The central bank of Uruguay conducted a successful pilot program for its digital currency e-peso in 2017, as announced by leading financial institutions. However, no large-scale implementation has been reported since then.
Thailand
The Bank of Thailand (BOT) has completed the second phase of testing its CBDC, Project Inthanon. The project started in August last year. The first phase focused on developing a proven concept of a decentralized real-time gross settlement system (RTGS) that uses CBDCs in a distributed ledger. Phase two, which has now been completed, began in February to further explore how DLT can be used to tokenize debt instruments issued by BOT to DLT and incorporate compliance and data reconciliation features into the DLT payment process. The third phase is under development and should be completed at the end of the year.
France
The European country began a pilot program for what was touted as the first digital currency, the euro, earlier this year, and has been successful in its first phase of testing.
Hack and predictor Aviator
Blockchain technology is relentlessly moving towards integration with traditional financial systems. The fact that CBDC has become a viable option in finance is a testament to the extent to which people and businesses are embracing technology.
Many countries are still exploring the CBDC concept, including the United States. Central banks are looking to integrate this new technology with the traditional monetary system to keep up with the dynamism of financial technology. The way payments are made has changed dramatically over the past decade and will continue to evolve as new technological breakthroughs emerge.