October 6, 2022

What is Central Bank Digital Currency? A Complete Guide

Central Bank Digital Currency is the digital form of a country's fiat currency, which is regulated by its central bank. Know more about what is central bank digital...

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The advent of cryptocurrencies in the global finance scene has been spelling trouble for centralized fiat finance for quite a while now, and now many countries have come up with the concept of CBDCs to combat the threat to fiat finance. A CBDC, or a central bank digital currency is digital money released by a country’s central bank, with its value pegged to the national fiat currency.

Countries including India and the UK already have plans to launch CBDCs like the Digital Rupee and the Digital Euro respectively. While CBDCs are being hailed as cryptocurrencies, their centralized nature does seem to be completely against the very principles of decentralization for the removal of intermediaries. In this post, we discuss in detail “what is central bank digital currency?”, and attempt to answer all the questions you may have regarding CBDCs.

Table of Contents

What is a Central Bank Digital Currency?

A central bank digital currency is a digital token form of the fiat currency which the issuing country uses, as mentioned before. The issuing country might leverage a private blockchain type ledger as opposed to an open source blockchain.

According to the governments that have plans to issue CBDCs, they are doing so to protect their citizens from losing money over bad investments in the unregulated crypto markets, and to match the pace of the digital financial revolution. However, centralized CBDCs do not offer privacy or control over one’s funds and transactions, which will make it difficult to get a backing from crypto/Web3 followers.

How Do Central Bank Digital Currencies Work?

A central bank digital currency can be considered a bridge joining centralized and decentralized finance. A government-backed central bank could issue CBDCs, and may also be responsible for managing different types of blockchain nodes associated with the crypto asset. It is also possible that the CBDCs may be modeled in such a way that a single ledger is maintained through decentralized principles although the level of decentralization can be expected to be modest at best.

How Safe are Central Bank Digital Currencies?

Many countries have so far assured that central bank digital currencies will be free from the market volatility of the usual crypto assets. They are backed by national fiat currencies, so there will certainly be lesser price fluctuations. It will be similar to privately issued stablecoins, albeit, with a government backing and authorization.

Types of Central Bank Digital Currencies (CBDCs)

So far, we can differentiate the upcoming central bank digital currencies into two categories based on factors like the types of blockchain nodes they use, the wallet used to store the assets, banking options provided, and more. Based on these parameters, these are the types of CBDCs that is said to be available for public usage:

1. Retail Central Bank Digital Currencies

It is currently the most preferred kind of CBDC because it allows financial stability to end users since the government directly backs the asset. These are centrally issued digital tokens that peg their value to a country’s fiat currency. It is most useful for people who do not have access to the traditional banking services of a country due to factors like geographical location.

2. Wholesale Central Bank Digital Currencies

Another popular kind of CBDC blockchain may come in the form of wholesale one, used by the central financial institutions of the country. Banks and other premier institutions will use them to process transactions safely and faster than the traditional financial method. The decentralized ledger used for wholesale CBDC can even be used for cross-border payments between financial institutions.

What are the Pros and Cons of CBDCs?

As many in the crypto space have already pointed out, central bank digital currencies come with their fair share of advantages and disadvantages. These would be:

Pros of CBDCs

Advantages of central bank digital currencies include:

It does away with the risks of major banking failures or bank frauds.
It lowers the time and cost required in a cross-border payment by automating the validation process and reducing the number of approvals required from regulatory bodies.
They complement the fiat currencies that they are pegged to, and have good exchange value.
It is great for the unbanked population of a country since they do not need to be physically present at banks to avail financial services.
Expensive infrastructure demands can be eliminated through direct contact between end users and central banks.

Cons of CBDCs

Disadvantages of CBDCs include:

It doesn’t abide by the central ideal of blockchain technology, i.e., decentralization.
It will not provide financial anonymity to the end users.
Citizens data is in the hands and whims of a centralized authority and will not be certainly immune to abuses seen before

Examples Of Central Bank Digital Currencies (CBDCs)

The Bahamas was one of the first countries to launch its digital token, the Sand Dollar. It is issued by the Central Bank of Bahamas, and the institution holds centralized control over the digital currency.

China has already started using its Digital Yuan in many provinces. It is currently being used for metro services, tax payments, bus services, and more.

Nigeria has been the first African country to launch its digital fiat currency, eNaira. It is based on a centralized blockchain ledger.

Finally, even the US has been calculating the cost and benefits of issuing its digital currency. The same goes for India, as it has also announced its plans to launch the Digital Rupee.

Now that you know What is CBDC? It's Pros & Cons also some of it's examples, also read an Overview of CBDC Efforts Worldwide ✍

Conclusion

We hope this post has given you answers to your queries concerning “what is a central bank digital currency?”. Even though the basic principle of blockchain-based crypto is to create a decentralized network of financial transactions, CBDCs can still be called some progress when it comes to mainstream crypto adoption. This implies the governments across the world are ready to understand the potential of different types of blockchain nodes and ledgers.

CBDCs can be especially great for those who do not yet want to venture into crypto trading but also want to avoid the traditional banking system. However, there is still a long way to go for the concept of central bank digital currencies.

Frequently Asked Questions (FAQs)

1. Is CBDC a Cryptocurrency?

While CBDCs may utilize blockchain technology and blockchain nodes like stablecoins, they can be considered the closest form of cryptocurrency that will be adopted by the governments first. CBDCs are the tokenized version of a country’s fiat currency and are regulated by the central bank, unlike a completely decentralized cryptocurrency.

2. What Is the U.S. CBDC?

While the U.S. aims to adopt a national strategy on CBDCs, currently there is no official digital currency of the US. Research is being conducted to evaluate the cost and the benefits it will add to the financial system.

3. Is CBDC Based on Blockchain?

While central bank digital currencies are supposed to be based on blockchains, many feel that CBDCs with their centralized nature is better off using a traditional ledger in digital form.