What is a Central Bank Digital Currency (CBDC)?

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What is a Central Bank Digital Currency (CBDC)?

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Inspired by cryptocurrencies, Central Bank Digital Currencies (CBDCs) are the digital form of fiat currencies like the US dollar or Euro.

Unlike decentralized cryptocurrencies, CBDCs are controlled by a central entity like the central bank or the government. This has raised some privacy issues regarding how these digital coins will be used for surveillance and tracking purposes.

CBDCs come in two major forms: Retail and Wholesale. The retail CBDC is designed for regular day-to-day transactions while the Wholesale one is meant for large interbank money transfers and transactions.

The popularity of cryptocurrencies like Bitcoin and Ethereum has urged many governments and central banks around the world to consider developing their own CBDCs to stay in the race of digital transformation.

In this article, you will learn about the basics of Central Bank Digital Currencies and their types, and how they differ from cryptocurrencies like Bitcoin and Tether.

What is Central Bank Digital Currency (CBDC)?

Central Bank Digital Currencies or CBDCs for short are the digital form of government-owned fiat currencies that are used as legal tender within an economy.

A central bank can control the supply and the issuance rate of a CBDC, in the same way they control the supply of fiat currencies through monetary policies.

With a CBDC, the history of all the transactions will be recorded by the issuing central bank and users will no longer have the traceless element of cash.

Central Bank Digital Currencies align with the idea of cashless societies and caught the interest of various central banks and governments around the world during the COVID-19 pandemic.

During that time, digital and contactless payments became mainstream as they prevented the spread of the virus, making the banking sector realize how far away from digitalization and financial inclusion they truly are.

At that time, cryptocurrencies offered an alternative to fiat currencies, specifically to those who did not have access to the banking system. The accessibility of cryptocurrencies and their unique features inspired central banks to offer the digital form of their fiat currency; a digital coin that would offer many of the innovative features of cryptocurrencies while being still controlled by them.

What is the difference between Central Bank Digital Currency (CBDC) and cryptocurrencies?

The main difference between Central Bank Digital Currencies (CBDCs) and cryptocurrencies is in the way they are maintained and controlled.

Leveraging blockchain technology, cryptocurrencies are decentralized, meaning they are not controlled by a central entity and are maintained by their community of users. Take Bitcoin for instance. Bitcoin is the largest cryptocurrency in the world and is open to everyone. No single entity owns Bitcoin and its supply, features, and underlying mechanism is defined by its code and cannot be changed or altered by the hands of only one single entity.

In this way, users will always be the true owner of their cryptocurrencies and can hold full ownership by keeping their crypto tokens in their own crypto wallets. You can read our “What is a Crypto Wallet?” article to learn more about different types of crypto wallets and find the one that would suit your needs the best.

Central Bank Digital Currencies, on the other hand, are controlled by the issuing central bank or government. The issuing authority will be in full control of its CBDC and can tweak its supply based on market conditions to manage the economy.

A CBDC will act exactly like fiat currencies and the central authority will hold the power to cease your account and money at any time.

Types of Central Bank Digital Currency

We have two main types of Central Bank Digital Currencies (CBDCs): retail and wholesale.

A wholesale Central Bank Digital Currency is mainly designed for interbank transactions and will be mostly used by the central bank and commercial banks for large transactions.

A retail Central Bank Digital Currency, on the other hand, is designed for the public and can be used in daily transactions. Like cryptocurrencies, they can also offer a faster and cheaper method of international transfers without the limitations of the traditional banking system.

Central Bank Digital Currency (CBDC) and Stablecoins: what’s the difference?

A Stablecoin is a type of cryptocurrency that follows the price of another relatively more stable asset like gold or the US dollar.

As cryptocurrencies may experience sharp price movements, stablecoins allow market members to hedge their assets against volatility by exchanging them for robust stablecoins during unstable market conditions.

Therefore, stablecoins are decentralized and built on blockchain systems. They are not controlled by a single entity and you are the sole owner of the stablecoins you keep in your crypto wallet.

A Central Bank Digital Currency, however, is the digital form of a fiat currency and is controlled and owned by the central bank or government.

Tether (USDT), for example, is a stablecoin that is pegged to the US dollar. In other words, it will always have a price close to 1 US dollar. A fictional digital dollar, on the other hand, will be the digital equivalent of the USD.

Central Bank Digital Currency (CBDC) and Privacy

Central Bank Digital Currencies (CBDCs) will not be anonymous and will record the smallest details of each transaction. This will provide governments with a powerful tool to record and trace people’s transactions. This enormous data then can be used to harvest meaningful insights into each person’s life and their online and social behaviors.

Considering this, many believe that CBDCs pose a serious threat to their users’ privacy and may become more of a surveillance mean than a tool to boost financial inclusion and economic freedom.

The insights gained from the data stored on a CBDC system can be misused for political purposes without the consent of the people.