Central Bank Digital Currency (CBDC): The Future of Money is Here?

Central Bank Digital Currency (CBDC) is the digital version of a fiat currency issued by the country’s central bank. 

Following the popularity of blockchain-based cryptocurrencies, it was only a matter of time before governments looked into the concept of bringing their own form of regulated virtual currencies, and CBDCs are just that. 

Most nations today are already in the process of developing and launching a digital currency. The idea that paper money might be a thing of the past no longer seems far-fetched.

But is it really going to happen, though? Will CBDCs pose a significant threat to cryptocurrencies? Are we going to entirely shift from paper currency to digital money?

We’ll be addressing all these questions and more in this guide. 

What is Central Bank Digital Currencies (CBDC)?

Central Bank Digital Currency (CBDC)

A digital form of currency issued by a government as a concept has been around for decades. Digicash and e-gold were some of the first virtual currencies issued by central agencies. However, these currencies never saw widespread support or usage. 

That changed with the introduction of Blockchain-based Bitcoin, followed by countless other cryptocurrencies. Suddenly it seemed as if these virtual currencies were here to stay and becoming an integral part of our lives. 

However, one major hurdle remained – cryptocurrencies can’t be regulated. Therefore, they could not get institutional backing.

The idea of digital money, though, found favor with the governments, and they rushed to launch their own version of digital currencies, i.e., Central Bank Digital Currencies (CBDCs).

CBDC is essentially a virtual form of physical currency (though with more advanced features) issued and regulated by the central bank in the form of tokens and electronic records. 

It can be further divided into two types – wholesale CBDCs and retail CBDCs. 

Wholesale CBDCs are for government bodies and financial institutions like banks. This will make interbank and cross-border transfers quicker and more efficient. 

Retail CBDCs, on the other hand, are meant for general population use. Think of them as digital cash that allows you to transact quickly and safely. 

Retail CBDCs are further divided into two categories – token-based retail CBDCs, and account-based retail CBDCs. Token-based ones allow the users to transact anonymously, while the latter requires digital authentication to access an account.

Other than that, the following are some features of a Central Bank Digital Currency to give you an idea of how it’s different from traditional paper money – 

  • Value is always at par with fiat money.
  • Instant and low-cost or free settlement.
  • Anytime transaction.
  • Backed by the central bank, hence secure.
  • Possibility of both online and offline transactions.
  • May not be anonymous.

Purpose of Central Bank Digital Currencies (CBDC)

The purpose of a digital central bank currency is to simply provide a better alternative to what we have today, whether that is paper money, traditional banking systems, which some might say are slow and inefficient or cryptocurrencies which are too volatile to use in day-to-day transactions. 

With CBDCs, we can achieve convenience, transferability, accessibility and efficiency. Not to mention all the other benefits that will come along with it, including:

  • Easier for governments to engage directly with people for welfare distribution or tax purposes.
  • It can help reduce or eliminate illegal activities like money laundering corruption, as all transaction details will be stored digitally.
  • It requires much less money and resources to manage when compared to traditional banking infrastructure.
  • Any hindrances caused by physical banks, such as banks running out of cash and employee strikes, can be negated with CBDCs.

However, CBDCs have their limitations as well, some of which are:

  • Prone to institutional influence as it is centralized.
  • Privacy and the ability to transact anonymously are compromised.
  • Although cross-border transactions will be improved with CBDCs, it can also be a source of headaches due to differences in the laws and regulations of different countries.
  • Financial crimes could affect CBDCs more when compared to fiat currency.

Are CBDC Cryptocurrencies?

There is a common misconception that cryptocurrencies and central bank digital currencies are the same. While it’s true that both are virtual currencies, there are quite a few crucial differences between them. 

Cryptocurrency, built on blockchain, is decentralized and unregulated, meaning it can not be subjected to any institutional influence whatsoever. It’s all peer-to-peer, so it doesn’t require you to reveal your identity to use it. 

Also, as mentioned before, cryptocurrencies are notoriously volatile, which makes it almost impossible to use an alternative to fiat currency. 

Some might argue that stablecoins, a coin whose value is pegged to fiat currency, gold or other commodities, solves this problem, but that is not true. 

While it’s true that stablecoins are more similar to CBDCs than other cryptocurrencies, at the end of the day, they, too, are cryptocurrencies. Therefore, they, too, are exposed to the same risks and limitations. The recent Terra Crash is a good example of what can go wrong with stablecoins and why there is a need for a government-regulated digital currency. 

CBDCs, on the other hand, are controlled and regulated by the central banks. It practically functions and operates the same way as traditional fiat currency, with the addition of less privacy and more influence from the government, which is both a good thing and a bad thing. 

Central Bank Digital Currency (CBDC) Different from Crypto

CBDC and Blockchains

CBDCs are built on blockchains, but not the kind that cryptocurrencies are built on. 

Crypto is built on public blockchains, meaning all transactions and operations are public records. Anyone can read, write and audit it, and that is what makes crypto decentralized. 

CBDCs, however, are built on private blockchains. As the name suggests, private blockchains only allow a selected group of people, i.e., the government bodies and central bank, to access, monitor and make changes to it, preserving the centralized nature of fiat currency. 

Countries Exploring Central Bank Digital Currencies (CBDC)

There were already talks and discussions around developing and implementing CBDCs in different countries. But the process accelerated after the pandemic when governments and financial institutions quickly realized the need for a better medium to facilitate transactions. 

As of now, 119 countries are exploring and dabbling around the concept of CBDCs, according to Atlantic Council’s CBDC tracker.

  • 72 out of the 119 countries are in their research and development stages, including the United States, Colombia, Brazil, Hungary, etc. 
  • 11 out of the 119 countries have already launched it for public (retail) use, including Nigeria, Bahamas, Jamaica and the Eastern Caribbean countries.
  • 17 out of the 119 countries are in their pilot stage, including Ukraine, Russia, India and China. 

Currently, the countries closest to launching a CBDC are – 

China: The world’s second-largest economy has already done trials in many of its provinces. In fact, the digital yuan has already crossed 14$ billion in the total transaction amount. 

India: India has launched a pilot program for its digital currency in a few locations and is planning to unveil the digital rupee before the end of 2023.

Is CBDC the Future of Money?

Going by the number of countries invested in researching, developing and implementing digital currencies, it’s safe to assume that CBDC will be a PART of the future of money. 

Improved cross-border payments, financial inclusion, quicker, safer, and more efficient payments and low transaction costs are all things that make central bank digital currencies a promising technological innovation. However, as mentioned before, it comes with its own limitations, such as lack of privacy and increased risk of cybercrime. 

Now, how will all of this play out in the long run? We’re yet to see.