What Are CBDCs And Why Should You Care?
5 mins read
8 days ago
With cryptocurrencies gradually becoming a part of the mainstream investment community, governments of nations and their central banks are seeking ways to come on board and play a role in the digital currency market.
To accomplish this, central banks have been experimenting with digital currencies to participate in the current wave of cryptocurrencies. A result of this adventure is the invention known as CBDC, meaning Central Bank Digital Currencies.
Numerous central banks worldwide, from countries like China to Sweden, South Africa, and Nigeria to the European Union's ECB, are working on their state-issued CBDC. This includes pilot programs, consultation papers, and research projects in recent years to see if CBDC could be issued as a digital supplement to cash in the future.
So what exactly are these CBDCs? Or central bank digital currencies? How will they affect you? Let’s dive deep to see how these could be a game-changer for government and global cryptocurrency adoption.
What Exactly Is CBDC?
CDBCs are also regulated, are meant to be stable, and have a value comparable to actual currency.
Types of CBDC?
There are two main tracks of CBDC, namely wholesale and retail types.
Wholesale CBDCs are the first type which facilitates payments between commercial banks and central banks or entities that hold their accounts with central banks. Now, these have more to do with the infrastructure and the plumbing of the financial system and don't affect you and me directly.
The other one is retail CBDC that businesses can use, as well as people like you and me. Imagine holding currency in your mobile wallet, and the money is directly issued by the central bank. This could have enormous implications for any country with so many unbanked or underbanked people in countries like us and other developing nations worldwide.
Retail CBDC could make a strong case for Financial Inclusion. A company like Yellow Card is making it possible with cryptocurrency in Africa because the central bank could directly transfer funds to the unbanked as long as they have a mobile phone. Imagine transferring funds for COVID relief or to help people during natural disasters.
Central Bank Backed Digital Currency
On the surface, it's not much different than putting electronic money in a bank account and sending it out into the world via cards, smartphones, or applications. The main distinction is that central bank money, like cash, is a risk-free asset. A tangible dollar bill, for example, is always worth one dollar. In contrast, a dollar in a commercial bank account is theoretically convertible into paper currency on demand.
This means that it is subject to the bank's solvency and liquidity issues. Consumers may not always be able to access it and may even lose it if the bank folds. On the other hand, CBDC, like banknotes and cryptocurrencies, would be the central bank's direct liability.
While various countries are investigating the feasibility of developing and issuing CBDC, no country has yet to do so. China, England, Sweden, Singapore, and Thailand are just a few countries whose central banks are working on proposals for CDBC consideration. China is the country that is the closest to launching a CDBC. China's central bank, the People's Bank of China, has been testing the digital Yuan since April 2021.
What Impact Would CBDC Have On Payments?
Transaction Speed: CBDC could take many forms, but one purpose would be to speed up payments. Commercial banks settle their net charges with one another using central bank money in the existing system. However, this procedure is often not instantaneous due to technological and operational reasons, posing a credit risk during the settlement period.
CBDC and digital currencies will be able to disrupt institutional bottlenecks and delays in financial partnerships in the private and public sectors of the economy.
Financial Inclusion: You've probably heard the expression "banking the unbanked" about cryptocurrency. It is a call to provide access to financial access to societies cut off from global technological advancements. Access to low-cost banking will drive financial inclusion in many developing populations. This makes CBDCs appealing from a centralised government perspective as a way to achieve the goal of financial inclusion for more citizens.
Economic Stability: The central bank could also utilise CBDC to influence monetary policy to spur spending. To kickstart the economy during recessionary periods, the central bank could theoretically add an expiration date to the money transfer, so you could be compelled to make purchases with that money instead of holding it. This would increase the velocity of money in the economy.
The opportunities are plenty, but a few risks are also involved. Why would we need commercial banks if we could all hold our money with the central bank? The conclusion reveals more.
What Is the Difference Between Cryptocurrency And CBDC?
CBDC have very similarities with cryptocurrencies, except for the potential technological design.
Volatility: CBDC is not the same as a cryptocurrency like bitcoin, which is too volatile to be used as a store of value and isn't widely accepted enough for transactions. While stablecoins are often pegged to fiat currencies, thus having stability, most cryptocurrencies are classified as speculative assets.
Centralisation: CBDCs are managed by a government’s central bank, unlike bitcoin and most other cryptos. While several countries are experimenting with complete or partial usage of the blockchain for their CBDC, it is not sure that they will do so.
Anonymity: When dealing with CBDC, you do not have the option of remaining anonymous. However, unlike crypto transaction details, which are available to the public, the transaction details will be available only to the sender, receiver, and bank.
While bitcoin may provide a more global solution, every country has a desire to meet the bespoke needs of its citizens. This is where CBDC will bring massive value to its users.
The new question might be, "Why keep money at your local commercial bank?" which could have severe ramifications for the entire banking industry.
However, central banks are unlikely to bother with that because, first and foremost, a robust banking system is critical for an economy's financial health. Furthermore, central banks are simply not designed to deal with millions of retail customers.
Disclaimer: This article is meant to provide general guidance and understanding of cryptocurrency and the Blockchain network. It’s not an exhaustive list and should not be taken as financial advice. Yellow Card Academy is not responsible for your investment decisions.