The Ultimate Guide to Central Bank Digital Currency (CBDC): Definition, Functionality, and Impact
CBDC is a digital payment instrument, denominated in the national unit of account
CBDC or Central Bank Digital Currency is a digital form of the fiat currency issued by the central banks of respective countries. It is not the same as the UPI payments or NEFT transfers where we use the same ledger as traditional cash. This form of central bank money is created and transacted over a Distributed Ledger Technology (DLT) — involving either permissioned or permissionless DLT.
This form of money is different from the balances we usually find in traditional reserves or settlement accounts. So, the CBDC is a digital payment instrument, denominated in the national unit of account, that is representing a direct liability to the central bank issuing the same.
Now, the question could occur quite naturally that when the central banks are already issuing paper currency notes and minting metal coins, why do they need to issue CBDCs?
Quite evidently — it isn’t just the digital nature of CBDCs which are attracting the central banks towards adopting CBDCs but there is something more.
Advantages of using the blockchain system for CBDC offering
1- It is a digital transparent ledger — so, hiding transactions would be impossible over it.
2- It is very difficult to create / issue digital CBDC unless the issuer (central banks) issues the same — which essentially means that the problem of counterfeiting banknotes will be taken care of permanently.
3- It is now known that the blockchain system creates a tamper-proof record, while the centralized ledgers of the banks can still be tampered with — so, the CBDC is more secured over a blockchain than a centralized ledger
4- CBDC is a digital instrument and does not require any physical branches to service the remote unbanked areas — so, it can work wonders for financial inclusion.
5- Another advantage of the CBDC system is that it brings about efficiency in payment systems. Multiple payment points can be included in the system and it could also simultaneously cater to large transaction amounts as well as manage the micro-payments digitally — without the involvement of low-value coins
6- Furthermore, a CBDC system provides the economy an alternative to cash and makes transactions seamless and it also helps the population from participating in the monopolistic and oligopolistic systems of payment applications.
CBDCs can be of broadly two types:
1- One that is used for domestic payment systems — this is termed as Retail CBDCs
2- Also that is used for cross-border payments — this is termed as Wholesale CBDCs
As more and more countries are coming up with their CBDC products — interoperability in major CBDC countries would become an issue to tackle later on. But, wholesale CBDCs present a very good opportunity to have transparent and tamper-proof cross-border payment systems which in turn improves the counterparty credit risk in cross border payments and settlements between banks.
One more advantage one could think of CBDCs are that it will widen the scope for crypto adoption in the general population. Confusion about the status of cryptocurrencies is a major deterrent to the adoption of cryptocurrencies in the mainstream. The concept of decentralized way of doing finance is a big hurdle to people who have proliferated in the centralized system and are habituated to it.
With a central bank adopting the decentralized version, it will be a confidence booster for the people to try out other crypto assets with confidence and help prosper adoption.
As of the end of 2021, we have seven countries that have launched their CBDCs — The Bahamas, St Kitts & Nevis, Antigua & Barbuda, St Lucia, St Vincent & Grenadines, Grenada and Nigeria. 16 countries which are in the pilot stage of launching their CBDCs — China, South Korea, Hong Kong, Thailand, Singapore, Malaysia, UAE, Saudi Arabia, Israel, Ukraine, Lithuania, Sweden, Jamaica, Anguilla, Montserrat and Dominica.
15 countries are in the development stage of which the most notable are Japan, Russia, Australia, South Africa, Brazil, Canada, Switzerland and France.
39 countries, including USA, UK, India, Euro Area are in the research stage, 8 have their projects held in an inactive stage and 2 have canceled their plans to launch a CBDC.
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