What are Central Bank Digital Currency

A new form of money came into existence when Bitcoin launched in 2009. It became a unique platform where you could instantly complete financial transactions across the globe. This was an upgrade over the other systems at the time. Even governments wanted to be a part of this new system due to the quick expansion of the blockchain industry. This led to the creation of Central Bank Digital Currencies.

How do CBDCs work?

Central Bank Digital Currencies are digital crypto tokens. CBDC has similar features to other crypto tokens. CBDC is the digital equivalent of the fiat currency of a country. For example, the upcoming Digital Rupee is a CBDC, and the Indian rupee is a fiat currency. The CBDC token is issued by the central bank of the country. The central bank also determines the supply of these digital tokens. The peg between the currency and the token is maintained by the central bank of the country.

CBDCs are simply the country’s digital currency. They provide additional benefits to the government, companies, and citizens as they intend to function similarly to a fiat currency.

Features of CBDCs

A central bank token must have several key characteristics to be an effective mode of payment. Some of these characteristics are listed below.

Token Features

  1. Accessibility: A token’s success highly depends on the convenience of its use. Systems to accept a digital token must be simple and fast. It also should be easy to understand.
  2. Low Cost: The transaction cost should be low or no cost to make sure it is easy to use as cash.
  3. Legal Tender: The CBDC token should be the country’s legal tender, meaning the CBDC token should be accepted anywhere in the country as a mode of payment.

System features

  1. Scalability: The system should handle massive volumes of transactions. Also, as the platform develops and attracts more users, it should have the scope to increase this volume.
  2. Secure: The main priority of the CBDC systems is security. Any user or company should not face any threat while using this token.
  3. Downtime: The CBDC network should be equipped to deal with outages. Users on the network should be able to send or receive transactions at all times.
  4. Instant: All the transactions on the CBDC network should be completed instantly. Bank transfers usually take some more time to complete transactions. Instant transactions in the CBDC system will allow it to compete with bank transfers.

Advantages of CBDC

One of the advantages of a CBDC is the ability to deter criminal activity. Central authorities can easily trace any criminal activity to its source as all transactions are stored digitally. Criminal activities are rare in this system as they can easily be found.

Government and policy functions can be easily implemented using CBDCs. Some functions include tax collection, direct deposits, and monetary policy. Automation helps the system by decreasing the work required to complete these functions.

Lastly, middlemen are made redundant in a CBDC system. The central bank and the government can connect with their citizens directly. Intermediaries like banks and other institutions are made redundant. Bank failures will have a lower impact on financial transactions as the CBDC system reduces the risk of a financial crisis.

Disadvantage of CBDC

The need for decentralization cannot be satisfied by CBDCs. The authority to control the digital token is still held by a single entity even though the CBDC system is decentralized using separate physical nodes. The central bank controls the CBDC ecosystem and can not be influenced by any individual.

Next, anonymity is a big concern associated with CBDC payments. A central authority decides the means of storing data as it controls the ledger. The government decides the level of anonymity in a CBDC system. All your personal information can be stored as well as every transaction, or the system can be completely anonymous.

Interoperability is a key characteristic of a successful CBDC. Today, some digital tokens are not using blockchains or are on separate blockchains. All digital tokens have to be on the same blockchain or be compatible with other blockchains to enable seamless international financial transactions. This makes it difficult for the government to choose how they would like to create their digital crypto token.

Let’s take a look at CBDCs worldwide

Governments across the world have actively participated in creating and adopting CBDCs. Countries like Nigeria, Grenada, the Bahamas, and Antigua have already launched their digital tokens. Many other countries are currently undertaking similar digital initiatives.

As per the Reserve Bank of India, the Digital Rupee will be rolled out in 2022. The RBI will make sure there is no disruption to the financial and banking systems during the rollout. This process will be gradual. Before going public, the RBI will go through several pilot stages and complete the proof of concept.

Next, the Digital Ruble is being worked on by Russia. It has been a long time in the making and is currently undergoing pilot trials. Despite having a complicated relationship with the cryptocurrency industry, Russia has always had a competitive edge in this field. The Russian government will have more control over its CBDC ecosystem while also constantly developing its system.

Finally, China also intends to launch its CBDC in 2022. The Digital Yuan, or e-CNY, will be used primarily for retail payments in China. The People’s Bank of China has already conducted several pilot trials in 2021.

Final thoughts

As compared to digital crypto tokens, Central Bank Digital Currencies have various other benefits. They might not allow high decentralization or may not be completely anonymous, but they are fast and secure. They showcase an exciting future in how the concept of money will function worldwide. Central Bank Digital Currencies will enable seamless transactions and ease of doing business. CBDCs will bring better innovations and opportunities to those countries going cashless and transforming into a digital economy.

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