A central bank digital currency (CBDC) is a digital form of fiat currency. As such, it’s established as money by government regulation.
The approach to designing a CBDC will likely depend on the issuing country. Some implementations will likely be based on blockchain or some other type of distributed ledger technology (DLT), while others could likely be just a centralized database. The blockchain-based ones will use a token to represent the digital form of fiat currency.
While we could argue that CBDCs are inspired by cryptocurrencies such as Bitcoin, they are quite different. CBDCs are issued by a state and declared legal tender by a government.
Key Concepts and Features
1. Enables public access
In case cash access is limited or suddenly phased out, it’s good to know that the public can easily access a CBDC. While it’s unlikely that cash use will be abolished entirely, CBDCs can also be used as a kind of digital banknote. Eventual adoption will mean ease of use and that both modes of payments are officially recognized by governing bodies.
2. Improves payment systems
CBDCs can improve the overall performance of payment systems. Streamlining to a digital platform will make transactions faster, guarantee user security, and cut money production costs.
Exchanging through a digital platform can also allow governments to remove low-denomination coins, like the penny in the United States. In April 2017, the Bank of Korea initiated a coinless society trial, allowing customers to receive change in prepaid cards instead of coins. This experiment has proved beneficial for the country, allowing it to save up to 53.7 billion Won on coin production.
While nothing is set in stone, the mainstream use of CBDCs can have a similar effect on a nation’s economy.
3. Faster transition to less use of cash
Cash use has significantly declined due to the introduction of credit cards, financial applications, and other digital tools. While a CBDC may not completely end the use of coins and bills, it will further promote electronic transactions. Both businesses and consumers can significantly benefit from this because digital exchanges provide increased convenience and security.
4. Secures cross-border payments
International transactions can be costly since manual data entry, interbank mediation, and other constraints can expose users to unwanted fees and settlement risk. Fortunately, a CBDC can eliminate time lags and other limitations thanks to its ability to identify transactions in real-time.
By reducing processing time and cutting costs, CBDCs can make cross-border payments more efficient.
5. Introduction of new technology
Now that we live in a fast-paced and technologically-advanced age, new technologies are constantly emerging. Similar to how Bitcoin and cryptocurrency have paved the way for advancements in the finance sector, the introduction of CBDC will inevitably bring about other innovations.
With the world gearing towards digitization, relevant agencies will need to find ways to support its use.
Functionally, they are somewhat similar — they both represent fiat money in the form of a digital token. However, under the hood, they are quite different.
The issuance of stablecoins is typically handled by a private entity and they’re basically a representation of fiat money or some other asset. They can be redeemed for the value they represent, but they aren’t fiat money. CBDCs, on the other hand, are issued by the government as fiat money.
CBDCs are different from cryptocurrencies. CBDCs are issued by a central bank and issued legal tender by the government. You could think of a CBDC like banknotes — it’s a unit of account, a means of payment, and a store of value.
True cryptocurrencies such as Bitcoin are quite different. They aren’t issued by a government and don’t really concern themselves with national borders. They are permissionless, trustless, and censorship-resistant. In addition, there is no centralized entity controlling the network. No one can blacklist your Bitcoin address from sending a transaction to another Bitcoin address.
So, which one is better? It depends on the use case. The fact that Alice can send Bitcoin to Bob without any middlemen or anyone having the ability to censor the transaction is a powerful idea. At the same time, it does have its downsides. What if a huge chunk of the money is stolen? What if Alice accidentally sends her life savings to the wrong address?
Sometimes, it can be useful for an entity to have the power to revert transactions or blacklist addresses. Other times, it’s more useful to reap the benefits that a decentralized network like Bitcoin can offer the world.
The idea of CBDCs has gained traction, and many financial institutions have conducted studies to determine their overall usability. With the features mentioned above, consumers, brands, and authoritative agencies have a lot to be excited about. However, only time will determine what its economic and societal implications will be.