Central Bank Digital Currency (CBDC)

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CBDCs are digital currencies issued by a central bank whose status as legal tender depends on government regulation or law.

What Are Central Bank Digital Currencies?

Central bank digital currencies (CBDCs) are fiat currencies that exist in a digital form and are issued by central banks.

CBDCs remain fully within the orbit of the traditional, intermediated financial system of fiat currencies, which are backed by trust in the currency’s issuer: a national central bank and ultimately, the sovereign government or political authority behind it.

They are a concept inspired by — but different from — true cryptocurrencies like Bitcoin (BTC) or Ethereum (ETH). CBDCs are fiat currencies like the U.S. dollar, euro or the Japanese yen, as they are issued by central banks of their respective nations in a digital form.

Worldwide Adoption of Central Bank Digital Currencies (CBDC)

As of March 2022, there are only a few numbers of publicly-available CBDCs, such as in The Bahamas, followed by Nigeria and the Eastern Caribbean Union. Mostly, they only exist in the form of proof-of-concept projects, like the digital currency/electronic payments (DCEP) of the People’s Bank of China, or the Uruguayan e-peso.

Nevertheless, with Bitcoin hitting new all-time highs in 2021, the world of cryptocurrencies and stablecoins became well sought-after which is when governments realized they need to come up with an alternative too. This explains that, as of June 2022, over 105 countries are considering issuing a CBDC according to the Atlantic Council. You can track the status of a country’s CBDC here.

CBDCs vs Fiat currencies

CBDCs may or may not employ a distributed database like the blockchain; however, they cannot be considered true cryptocurrencies. They are not decentralized due to the fact that their issuing central banks maintain complete control over production and distribution — in the same way as they do with traditional fiat currencies. Their value is also not backed by anything other than the public’s trust in the issuer.

CBDCs do, however, offer several advantages over fiat money, such as the ability to send them directly to other parties without having to rely on third-party payment processors. CBDCs also offer more control by the government over its circulation, resulting in a more efficient implementation of monetary policy.

The Federal Reserve also published a paper highlighting the benefits of a CBDC. One of the benefits highlighted the potential of CBDCs to replace the existing cross-border payments systems, as it is a significantly cheaper and faster alternative. However, to achieve so, a high level of global cooperation would be required. The paper also stated that CBDCs can help decrease the use of paper money that is free of credit and liquidity risk.

CBDCs are issued by a competent monetary authority of a country and are regulated by the same. This form of currency is not the same as cryptocurrencies.

How Are Central Bank Digital Currencies (CBDC) Designed?

Account-based and token-based CBDCs are the two frequently-used design formats. Central banks from all around the world have to keep certain features of the CBDCs in mind, including access, privacy and the method of distribution. This is because CBDCs are still completely within the orbit of traditional currencies which is why they must be easily accessible by all the users and should not be too complex as it could make it quite difficult for the users to transact.

Token-based CBDCs

Token-based CBDCs allow universal access to all the users at the cost of higher law-enforcement measures. The token-based technology works in a similar way to that of the blockchain as it functions using the distributed ledger technology to confirm the chain of ownership to validate transactions. It may also result in a high risk of end-users losing keys or tokens held in a non-custodial wallet.

Account-based CBDCs

As the name suggests, account-based CBDCs rely on the identity of the bank account holders. This is why account-based CBDCs require digital identification to access an account. This is a method that is not used as often due to the fact that it still relies on a constant relationship with a bank. When a transaction is carried out, each payment is processed separately by banks by debiting the sender’s CBDC account and crediting the receiver’s account. The bank accounts help in verifying the identities of both parties in a transaction which requires advanced systems to uniquely verify each user on the payment system.

The responsibility of CBDC’s operations and circulation lies with the country’s monetary authority or central bank. In its simplest terms, unlike cryptocurrencies, a CBDC is a government-backed currency. However, countries like El Salvador are making waves by adopting Bitcoin as legal tender. Unlike Bitcoin, which is a decentralized cryptocurrency, a central bank digital currency (CBDC) is centralized and regulated. They are officially used as a medium of exchange in countries along with official currencies.

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