Understanding Central Bank Digital Currencies (CBDC)
Central bank digital currencies have the potential to transform the financial ecosystem with wide-ranging benefits. Learn more about CBDCs right here now!
Money is one of the significant aspects of the global economic ecosystem. Presently, it seems impossible to run an economy without money, doesn’t it? Over the course of time, money has gone through evolutionary changes with the earliest forms such as bartering, followed by commodity-based money and then coins and paper-based money. However, the demand for e-money has constantly been increasing in recent times, with an increased focus on digitalization.
Furthermore, recent developments in the field of retail payments, announcement of Facebook’s cryptocurrency, Libra, and the radical decline in cash usage have turned attention towards the need for central bank digital currency. Let’s find out what central bank digital currencies bring to the modern financial landscape.
Why Central Bank Digital Currencies?
In order to find out more about CBDC, it is important to reflect on its origins. The two most common forms of digital money evident in the present times refer to the fiat money in central bank accounts and the crypto variants of fiat currency. The crypto variants of fiat currency are referred to as cryptocurrency. Interestingly, the number and value of cryptocurrencies have been growing impressively, with prominent challenges for monopoly of central banks in issuing money. The capitalization of crypto assets increased to almost $370 billion USD in August 2020.
At the same time, cryptocurrencies have also had their share of notable setbacks. Some of the common pitfalls observed in the case of cryptocurrencies include decentralized control over cryptocurrencies, higher volatility, and unpredictability.
However, new digital currency models such as stablecoins can provide better price stability for cryptocurrencies by pegging against fiat money. Therefore, central banks must look for central bank digital currency options to sustain their competitive advantage in this constantly evolving market. Since central banks are the primary authority for money, central banks should also evaluate and explore possible opportunities and risks with new digital currency alternatives.
So, what exactly is a central bank digital currency?
As a matter of fact, there is no clear definition for central bank digital currencies. A CBDC is considered as a new variant of digital currency that,
- Has the liability of a central bank
- Serves as a medium of exchange
- Serves as a store of value
- It is available in denominations of an existing unit of account
Therefore, central bank digital currencies are basically electronic forms of central bank money, which businesses and individuals can use for making payments and storing value.
Variants of CBDCs
The next important aspect of understanding central bank digital currency refers to the types of CBDCs. Central bank digital currencies are broadly classified into wholesale and retail CBDCs.
Wholesale CBDC is suitable for financial institutions holding reserve deposits with the concerned central bank. On the contrary, retail central bank digital currencies are tailored for corporations, individuals, and households. The objective of introducing CBDCs is a formidable factor in determining the type of CBDCs that you should use.
A wholesale CBDC would be suitable for improving cross-border payment efficiency or the wholesale settlement system. Such types of CBDCs will not be available to the general public, and they would not accrue interest. On the other hand, retail central bank digital currency is suitable for improving financial inclusion. Retail CBDCs will have availability for the general public alongside providing anonymity with possibilities for accruing interest.
Existing Applications for CBDCs
The popularity of central bank digital currency is also another crucial aspect for beginners to understand. Presently, more than 60 central banks all over the world are interested in assessment of potential impact of CBDCs. The massive adoption of retail CBDCs focuses on improving efficiency of domestic payments, ensuring financial stability and inclusion alongside strengthening payment safety. Let us take a look at some of the notable examples that shed light on the popularity of CBDCs.
Riksbank in Sweden is presently working on the concept of E-Krona as an alternative means of payment with state-guarantee. On the other hand, the concept also creates concerns for the dependence of payment systems on private players.
China has shown promising prospects in the field of central bank digital currency development. The country does not have any issues of disintermediation, as the Chinese central bank can offer the required infrastructure. At the same time, the public would have to use CBDCs in liaison with payment service providers and commercial banks.
The Federal Reserve Bank in the US is presently undertaking a collaboration with MIT for building and testing a CBDC. The FED is interested in understanding and evaluating the effect of issuing central bank digital currencies. In addition, the FED is implementing initiatives for discovering the implications of CBDCs for financial stability, payments landscape, banking and finance, consumer protection, and monetary policy.
Advantages of Central Bank Digital Currencies
Now, it is inevitable for any beginner to wonder about the benefits of central bank digital currency. Basically, the benefits of CBDCs are the foremost reasons for driving their popularity. Here is a brief overview of the significant advantages associated with central bank digital currencies.
CBDCs designed on a Distributed Ledger Technology (DLT) foundation can offer a trustworthy alternative to cash. Consumers don’t have to worry about any technological disruptions, attacks, or tampering with CBDCs.
CBDCs provide an alternative programmable currency that can support the integration of specific transactions like automatic dividend payments to stakeholders.
The role of central bank digital currency in promoting cross-border payments alongside financial inclusion also contributes to their popularity. CBDCs can enable flexible public access to government-supported payment systems, even without bank accounts. In addition, CBDCs can support digitalization of identity alongside digitization of money to support efficient cross-border payments.
Therefore, it is clearly evident that central bank digital currencies can be the next big thing in the financial ecosystem. As the demand for central bank digital currency continues to increase, enterprises are looking for opportunities to leverage DLT for creating CBDCs. At the same time, it is also crucial to notice the potential challenges that can emerge with adoption of CBDCs. However, the promising benefits of CBDC provide a favorable impression of the potential opportunities for their adoption. The radical shift towards digital money will definitely fuel the interests of central banks in CBDCs. Are you ready for the change?