Everything you need to know about Central Bank Digital Currencies (CBDCs)

Everything you need to know about Central Bank Digital Currencies (CBDCs)
Central banks around the world are exploring the potential implications of issuing a digital version of their national currency. In this article, we will be discussing everything you need to know about the Central bank digital currencies (CBDCs).
<strong>Everything you need to know about Central Bank Digital Currencies (CBDCs)</strong>
Everything you need to know about Central Bank Digital Currencies (CBDCs)

Known as a central bank digital currency (CBDC), this approach would see monetary authorities issue a token that serves as an equivalent to the local currency but operates through a blockchain-based payment system.

A move by a central bank to issue its own digital currency could have implications for how these institutions do business, how market participants respond, and what that means for our broader understanding of money in the digital age.

This article will offer insight into what exactly a CBDC is, why central banks are exploring this option, what they stand to gain from doing so and what challenges they may face along the way.

What are Central Bank Digital Currencies (CBDCs)?

A CBDC is a digital version of a national currency issued by a country’s central bank. In a world where people are increasingly using digital payments and cash is becoming less common, a CBDC could enable a “cashless society” where all transactions are digital.

CBDCs have become a topic of interest among central banks because digital currencies could offer a cheaper, faster, and more secure way of making payments.

CBDCs could also have other benefits for the economy and the central bank, such as improving the central bank’s ability to manage monetary policy.

CBDCs are a subset of a broader category of digital currencies called central bank digital currencies (CBDCs). While the terms “digital currency” and “CBDC” are often used interchangeably, CBDCs are a more specific type of digital currency.

What is the purpose of CBDCs?

The main purpose of CBDCs is to enable greater use of non-cash payments by individuals, businesses, and other economic actors.

By increasing the use of digital payments, CBDCs could potentially make financial transactions more efficient and reduce the costs of making payments. CBDCs could also help reduce fraud, as the use of digital payments reduces the risk of identity theft and other fraudulent activity.

CBDCs could also give central banks an opportunity to explore new models of financial inclusion, enabling the underserved to access the financial system more easily.

Digital payments can be cheaper and more accessible than those made in cash, giving people without access to traditional financial services the ability to make low-cost payments online.

Key features of CBDCs

These are some key features of CBDCs:

  • Token-based system
  • Distributed Ledger
  • Centralized issuance
  • Seigniorage

Token-based system

CBDCs are digital tokens that function as a stand-in for the national currency. CBDCs could be designed to replace paper money, or they could supplement cash in the economy by coexisting alongside paper currency. –

Distributed ledger

CBDCs operate through a distributed ledger system, similar to blockchain, that records all transactions securely and transparently.

Centralized issuance

CBDCs are centrally issued by a country’s central bank, as opposed to cryptocurrencies like bitcoin which are decentralized and self-issued.

Seigniorage

CBDCs are created by the central bank when they issue digital currency, so the government can profit from the process. This is known as seigniorage and is the difference between the production cost and the face value of the new money.

Types of CBDCs

These are the types of CBDCs after our research:

  • Federated
  • Issued

Federated

In a federated model, a CBDC would exist separately from the country’s existing digital payment system, alongside other cryptocurrencies. While it would be connected to the central bank, the digital currency would likely be operated by commercial entities.

Issued

In an issued model, a CBDC would be integrated into the existing digital payment system and likely replace the use of other payment systems.

Countries that have CBDCs

These are some countries that have CBDCs:

  • Switzerland
  • Japan
  • China

Switzerland

The Swiss National Bank (SNB) recently announced that it would investigate issuing a digital version of the Swiss franc, known as a Swiss Franc Digital Currency (SFDC).

<strong>Everything you need to know about Central Bank Digital Currencies (CBDCs)</strong>
Switzerland

While the central bank did not specify exactly when the SFDC would be issued, it did confirm that it was actively exploring the option.

Japan

The Bank of Japan (BoJ) has planned experiments on a digital yen with three megabanks and regional banks in the country.

<strong>Everything you need to know about Central Bank Digital Currencies (CBDCs)</strong>
Japan

Starting in the spring of 2023, the BoJ will work with private banks and other organizations to identify any problems with deposits and withdrawals and check that a central bank digital currency (CBDC) can operate during natural disasters and in areas without internet access, according to the report.

China

China has been exploring a potential digital currency since 2014, although the first actual test of the e-CNY system was not until 2020 with an initial trial launch in Shenzhen, Suzhou, Chengdu, and Xiong’an. 

<strong>Everything you need to know about Central Bank Digital Currencies (CBDCs)</strong>
China CBDC

These tests were expanded in 2021 to Hainan province, Shanghai, and a number of other cities.  As of April 2022 further expansions are planned for other major Chinese cities and Hong Kong, as well as a likely release at the Fall 2022 Asian Games. 

Advantages of CBDCs

Here are some of the advantages of CBDCs:

  • Increased efficiency in Payments
  • Greater financial inclusion
  • Improved monetary policy

Increased efficiency in payments

The use of CBDCs could increase the efficiency of payments, as payments are made digitally rather than in cash.

Greater financial inclusion

Digital payments could enable greater financial inclusion, as they require less infrastructure than cash payments and are accessible to everyone with access to the internet.

Improved monetary policy

CBDCs could allow central banks to monitor and track financial activity more easily, and therefore improve their ability to manage monetary policy.

Disadvantages of CBDCs

These are the disadvantages of the CBDCs according to our research:

  • Loss of anonymity
  • Security concerns
  • New challenges for monetary policy

Loss of anonymity

The use of CBDCs could undermine the anonymity of financial transactions, as payments would be tracked and recorded by the central bank.

Security concerns

If not implemented securely, a CBDC could put personal information at risk of data breaches and hackers.

New challenges for monetary policy

If CBDCs are issued by the central bank, they could pose new challenges to monetary policy. If CBDCs are widely adopted, the central bank’s ability to influence the money supply could be reduced.

Conclusion

A CBDC would be a significant development for the financial industry, bringing about significant changes in how people make and manage payments.

While a CBDC could offer significant benefits, it also poses potential risks to financial stability, privacy, and the central bank’s role in the economy.

There is no indication that any country is close to issuing a CBDC, but the concept remains one that is being actively explored by central banks.


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