The development of blockchain technology and creation of cryptocurrency have sparked interest in other digital forms of currency including the Central Bank Digital Currencies (CBDCs). Many countries are already investigating and developing their own form of CBDCs, which will be transformative to the digital economy.
So what exactly are CBDCs and how are they different to cryptocurrencies? In this TokenMason article, we explore what CBDCs are, how they are different to cryptocurrencies and discuss their purpose as well as their limitations.
What are CBDCs?
Central bank digital currencies (CBDCs) are digital forms of currency issued by central banks. A central bank is a public institution that manages a country’s monetary policy, such as controlling interest rates and money printing. CBDCs aim to peg the value of a country’s own fiat currency by central banks.
The main objective of CBDCs is to provide individuals and organizations a seamless, way for transacting using digital forms of currency that can be tracked electronically on a database and aim to provide better accessibility, efficiency and convenience than physical forms of fiat currency such as notes and coins.
Although, CBDCs are believed to be inspired by the creation of cryptocurrencies, they are not the same thing. This is because, by definition CBDCs are not decentralized, since they are issued and regulated by a central authority, which is a country’s central bank.
Some critics of CBDCs argue that CBDCs do not necessarily utilize blockchain technology and have a central authority such as a central bank, which defeats the purpose of being decentralized. The other alternative digital method some central banks have considered are stablecoins. Stablecoins are digital currencies that use blockchain technology and peg their market value to a fiat currency, physical commodity or financial asset. Please read TokenMason’s article about stablecoins using this link.
Having CBDCs and cryptocurrency are not necessarily mutually exclusive given users can still opt to use cryptocurrency if they wish to adopt a decentralized and anonymous way of transacting, while other users may prefer to transact using CBDCs if they wish to have their currency backed and governed by a central authority such as a country’s central bank.
Types of CBDCs
Many countries are already developing CBDCs, and some have even started developing them. For example, in February 2022, India’s central bank announced that it would introduce a digital rupee by the end of 2023. Under the Biden administration, the US government is currently investigating how CBDCs can improve the efficiencies in domestic payments system and reduce transaction costs by allowing CBDCs to be traded directly between users without an intermediary such as a commercial bank.
There are two types of CBDCs, wholesale and retail. Wholesale CBDCs are primarily used by large financial institutions such as banks. Retail CBDCs are used directly by consumers and businesses. It’s important to note that the two types of CBDCs can still co-exist and function simultaneously in the digital economy.
- Wholesale CBDCs: Wholesale CBDCs are for financial institutions that hold reserve deposits with a central bank. The central bank grants an institution an account to deposit funds or use to settle interbank transfers.
- Retail CBDCs: Retail CBDCs are government-backed and issued for the general public and used by consumers and businesses. Features of retail CBDCs include can traceability, instant settlements and the inclusion of interest rates.
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We hope you have found this blog useful and learned more about CBDCs and how they work. Please visit our Blog page for more blockchain related news and articles. For example, you may be interested to read our articles about blockchain and cryptocurrency.
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