How CBDC works, and What’s the Difference From Other Forms of Money?
CBDC is the acronym of Central Bank Digital Currency, also known as digital fiat currency or digital base currency. Central governments around the world felt the need for government-backed digital currencies to counter the growing influence of cryptocurrencies in 2017. That’s the year when cryptocurrencies started gaining tremendous traction.
In 2018, the market meltdown also made cryptocurrencies the talk of the town. Therefore, we can say that the roots of CBDCs lie with cryptocurrencies. But unlike cryptocurrencies like Bitcoin, Ethereum, and other cryptocurrencies, CBDCs are centralized as authorized financial institutions are liable to manage them. Let’s take a detailed look at what’s the CBDCs concept all about.
How will CBDCs Work?
As central banks will issue CBDC, it will have some characteristics like that of physical cash. Each CBDC issued by the Central Bank will have a unique identifier code to prevent counterfeiting. CBDC holders will be able to use it for payments, as a store of value, and unit of accounts. It is very likely that every CBDC that is in circulation will be backed by the gold, oil, and monetary reserves of a country.
Technology Powering CBDCs
When it comes to the underlying technology powering CBDCs, there is no common consensus among Central banks. The most likely technology to be selected for CBDCs is none other than blockchain and distributed ledger technology, which are also the backbone of cryptocurrencies like Bitcoin and Ethereum.
The reasons behind the upper hand of blockchain and DLT in use for powering CBDCs are multifold. These technologies are built to support digital monetary systems by minimizing the inherent risks.
Employing blockchain and DLT will also make the digital infrastructure for CBDCs interoperable. Thus, the system of one CBDC will be able to operate in conjunction with other CBDCs.
Another major reason for the prioritization of blockchain and DLT for CBDC is that these technologies simplify the process of constructing an appropriate system for digital fiat currencies, which otherwise would be far too complicated and complex.
How is CBDC Different From Other Forms of Money?
There are a variety of forms of money, which include fiat currency, cryptocurrencies, and more. So, how do CBDCs differ from other forms of money?
The only thing that differs CBDCs from the government-backed fiat currency is that the CBDC is a digital version of the fiat currency. As for the difference between cryptocurrencies and CBDCs, the CBDCs are centralized. They are controlled by the central banks of respective countries. Cryptocurrencies, on the other hand, are decentralized. Hence, there is no one entity pulling the strings in cryptocurrencies.
Though not exactly a form of money, many people wonder how cryptocurrencies differ from credit cards. Well, there is a big difference between them. CBDCs are managed by the Central banks of the countries issuing them, unlike credit cards, which are under the purview of private banks.
Who is Working on CBDCs?
Bank of England was the pioneer of CBDCs. But they aren’t the first ones to come out with a working model of CBDCs. Instead, it was China, who became the first country to launch a CBDC, popularly known as Digital Yuan.
The People’s Bank of China began working on digital yuan in 2014. They aimed to replace some portion of the cash circulating in the market with digital yuan. The official name of China’s digital yuan is Digital Currency Electronic Payment (DCEP).
Digital yuan will be distributed to the country’s masses via the two-tiered distribution model. The initial phase of distribution begins from the disbursement of digital yuan from the People’s Bank of China to banks, in the country. The further distribution of digital yuan will be taken care of by the commercial banks in China. They will be distributing it to the people in China.
There are many other countries in the race to launch a CBDC. In a recent survey by BIS, they found that 86% of central banks are working on CBDC. In the last four years, the number of central banks working on CBDCs has increased by one-third. The number of central banks working on CBDC proof of concepts stands at 60%, compared to 42% in 2019.
Other central banks in the race to develop CBDC include Sveriges Riksbank, European Central Bank, Bank of England, Federal Reserve Bank, among others. In fact, BIS is collaborating with six central banks for CBDC, which includes Sveriges Riksbank, Bank of Canada, the Bank of England, the European Central Bank, the Bank of Japan, the Federal Reserve, and the Swiss National Bank.
Considering the onslaught that the central banks were facing from cryptocurrencies and digital transactions, they had to do something. To tackle these challenges, Central banks came up with CBDCs. It will help them retain control over financial transactions in areas under their jurisdiction.
If we go by the popularity of stablecoins, the central banks are likely to be successful with the launch of CBDCs. It is interesting how far cryptocurrencies have come as they made central banks take notice and put them in a defensive mode.
CBDCs are a definitely interesting and innovative form of money that many central banks are working on. It may change the digital transaction landscape. As we are talking about interesting and innovative projects, we believe you should go ahead and check out Zild Finance. We are bringing in the much-needed change to the DeFi lending space. Visit our website for more details.
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