Central Banks Digital Currencies (CBDCs) – All You Need to Know

Beginner’s Guide / 12.02.2020

In late 2019, China shocked the world when President Xi Jinping announced in a conference that China is going test a Central Bank issued Digital Currency (CBDC). The move was incredibly shocking because historically, China had been skeptical of Blockchain tech. The announcement made by China wasn’t the first, as several countries had already announced that they were going to issue CBDCs soon. CBDC can be considered the current trend among Central Banks and governments worldwide.

And so, the question remains, why are so many governments interested in CBDCs? What actually are CBDCs and how are they different from already existing forms of electronic cash? Can CBDC actually mitigate the risk Bitcoin and other cryptocurrencies pose towards centralized currencies?

Let us discuss below.

CBDCs – The Competition to Decentralized Currencies

Briefly, a Central Bank Digital Currency or CBDC is a form of traditional money, but in digital form. They will be issued and governed by a country’s Financial authority, the Central Bank. Worldwide, CBDCs represent centralized authorities’ fight back towards decentralized cryptocurrencies. Governments fear that if they lose the power of issuing money, they might lose power all together.

In theory, a CBDC is a highly secure digital instrument like paper notes. CBDCs will function as a means of payment, a unit of account, and a store of value.  Like paper currency, each unit is uniquely identifiable to prevent counterfeit, thanks to the security of a distributed ledger. Essentially, a CBDC will be a digital version of the pre-existing fiat currency, or could represent something else altogether.

Electronic Cash that exist today function as a replacement to physical notes. Almost all e-cash requires a Settlement Authority to store the value for its users. Companies like PayPal, Venmo, etc. function as intermediaries in moving Electronic Cash. There is no form of direct ownership involved.

What makes a CBDC different from all the other forms of money stored in a digital form is its database structure. CBDCs would not only be representations of money, but complete replacement for notes, coins and digital alternatives.

A central bank digital currency would likely be implemented using a database run by the central bank, government, or approved private-sector entities. The database would keep a record of the amount of money held by every entity. In contrast to cryptocurrencies, a central bank digital currency would be centralized, and so a blockchain would not be required. CBDC will run on an approved form of Distributed Ledger Technology (DLT).

Issuing a Digital Currency comes with numerous advantages that all governments can take advantage of. By completely digitizing value transfer, a new era of e-Governance can begin.

Advantages of Issuing a Central Bank Digital Currency

  • Transparency
  • Ease of Tax Collection
  • Increase in Velocity of Money
  • Financial Inclusion
  • Removal of Intermediaries
  • Ability to Customize and Build on the Currency

Top 4 Countries Experimenting with CBDC

Venezuela

In February 2018, the government of Venezuela launched a national cryptocurrency called the Petro, or Petromoneda. With the launch, Venezuela became the first country in the world to successfully implement a form of CBDC. The Petro, however, is different from all other CBDC projects, as it represents a Medium of Exchange other than Venezuela’s already existing fiat currency – the Bolivar. Petro was Venezuela’s attempt to curb the hyperinflation rampant in the country. It is claimed that each Petro issued it backed by barrels of petrol, making Petro one of the only assets backed sovereign currency.

China

In late 2019, China stepped up its gaming by surprising the world about its plan to test and issue a CBDC. China proclaimed its excitement about Blockchain technology and showed interest in leading the world when it comes to innovation in Blockchain. The country plans to expand the scope of CBDCs. They will move beyond their simple function was a currency and expand to sectors like transportation, education, medical treatment and so on. How China plans to pull it off is yet to be seen.

India

In response to their criticisms on “illegitimate” tenders such as Bitcoin, the Reserve Bank of India announced that they too will be issuing a CBDC. India, who has historically remained against the development and adoption of Bitcoin, looks to mitigate the risk by issuing a sovereign-backed alternative. Although no other major announcement has been made with regard to the project, it remains to be seen how India will handle the issuance. It will not be easy issuing a digital fiat alternative as the people of India have been demographically cash dependent for generations.

Canada

The official website of the Bank of Canada says

We (hope) quantitatively that the effects of a CBDC on lending, deposits, output and welfare can be sizable.

This is a huge statement as it shows the interest and confidence that a country such as Canada has on CBDC. Canada hopes to finish test and experiment, so that a form of CBDC is ready by late 2020.

Conclusion

As a CBDC will be looking to compete with Blockchain based decentralized cryptocurrencies, it will try to implement all their features. A cryptocurrency has value because the decentralized ledger that the network uses believes that it does. On the other hand, a CBDC has value because the central bank or sovereign government that issues it, says that it does. CBDCs will contain most of the features of blockchain such as trust-less transfer, transparency, customization, application stack and so on. But the key difference will be the centralization that comes with CBDCs.

CBDCs could be seen as central banks’ response to the growing popularity of cryptocurrencies, which bypass regulators’ purview by design. CBDCs aim to take the best from cryptocurrencies — namely the convenience and security, and combine those features with the time-tested features of the conventional banking system, where money circulation is regulated, and reserve-backed. Although it is considered an oxymoron, as Blockchain was developed to remove centralized control, many see the growth of CBDCs as advantageous. As more and more countries get into developing, the market will get clearer about the use, if any, of a Central bank Digital Currency.

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Sudarshan M is a long time crypto-enthusiast. Pulled in by bitcoin early on, it did not take long for Sudarshan to divert all of his academic attention from business studies to blockchain by doing his Masters and eventually pursuing his PhD in the subject.