Unpacking Central Bank Digital Currencies (CBDCs)

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The use of digital assets has increased in society and the financial system at large and can no longer be ignored. After considering the many advantages of technological advancement, financial institutions have begun investigating how to include the technology backing digital assets into the current economic system. As such, the rise of privately issued currencies has prompted central banks worldwide to explore a central bank-issued digital currency. 

Crypto Daily is dedicated to offering its readers valuable information and thought it well to unpack and demystify CBDCs. Through a series of comprehensive articles, we will explore all aspects of CBDCs, ensuring our readers understand this emerging technology as we evolve into a cashless society. 

This introductory article will discuss what CBDCs are and touch on the two categories of CBDCs. A further section will discuss the benefits of CBDCs. 

What Are CBDCs?

Understanding central bank digital currencies (CBDCs) is a type of digital money is crucial. Technological development led to the advancement of the forms of money. Society has evolved from using a barter system in which goods and services were exchanged, collectables as money, to physical money such as coins and banknotes, to digital money, which exists on computers. Digital money has been revolutionized by blockchain technology into a system where society is exploring programmable digital money issued by central banks – CBDCs. 

The Bank of England explains that CBDCs are money issued by a country’s central bank. It is digital as it does not take the form of physical money such as notes and coins and is in the form of an amount existing on an electronic device such as computers. According to a recent blog by IBM, CBDCs are a digital iteration of “fiat money that is issued by central banks.” CBDCs can essentially be understood as a digital representation of a country’s physical currency.  

The Bank for International Settlements (BIS) describes CBDCs as a form of digital currency issued by central banks but different from digital balances used in the traditional central banking system. CBDCs are widely accepted to serve as a medium of exchange and a store of value. 

While crypto assets and CBDCs both rely on blockchain technology, they differ vastly. One key differentiating element between crypto assets and CBDCs is that CBDCs are backed by central banks and are legal tender. Digital and crypto assets, on the other hand, are privately issued, the BoE explains. IBM explains that central bank digital currencies operate on secure and transparent blockchain networks, which create immutable records of all transactions. An immutable record means transactions are recorded on a decentralised ledger, meaning they cannot be modified or tampered with. 

As CBDCs are managed by a central bank, they hold the same security as cash, while cryptocurrencies are not controlled by a central authority and are volatile in nature.

CBDCs were introduced to improve the efficiency of payments and reduce the costs associated with physical currency, such as printing, storing, and transporting. 

The following section will discuss the two categories of CBDCs: wholesale and retail. 

Retail and Wholesale CBDCs

CBDCs are classed into two categories: retail and wholesale CBDCs. 

Retail and wholesale CBDCs differ mainly in terms of accessibility. Retail CBDC acts similarly to cash meaning and will be issued to the general public. This category of CBDC functions like cash, allowing people to send and receive money, pay for goods and services, and receive grants and payments directly from the government. Retail CBDCs are anonymous, traceable, always available, and interest-bearing. According to a blog post by Consensys, the majority of central banks agree retail CBDCs adhere to several key features, including:

• CBDCs are a new form of central bank money controlled and issued by the central bank.
• As opposed to commercial bank money, CBDCs are a liability to the central bank balance sheet.
• Retail CBDCs are legal tender, should be accepted as a means of payment, and are a “safe store of value by all citizens, enterprises, and government agencies.”
• CBDC should be distributed with a 1:1 parity with a central bank’s relevant fiat currency.
• To use and obtain a CBDC, consumers do not need a bank account.
• Transaction costs should be lower than existing systems. 

Wholesale CBDCs, on the other hand, are restricted to financial institutions and aimed at interbank payments. Used as an addition to, or replacement of, real-time gross settlement systems (RTGS), wholesale CBDC are not accessible to citizens, Consensys explains. 

Benefits of CBDCs

CBDCs are being developed for various reasons and offer multiple benefits. They are digital versions of fiat currencies issued and backed by central banks. They have gained attention due to their ability to address the challenges of digital payments and the proliferation of privately issued currencies. 

One of the main benefits of CBDCs is their ability to provide a reliable and secure means of digital payments and remittances. In a recent article, Forbes discussed the advantages offered by CBDCs and explained they can be used for both online and offline transactions and can be integrated into existing payment infrastructure. Settling cross-border payments is often challenging with fiat money, and CBDCs can offer an alternative to facilitate such payments. 

In a recent report, the Official Monetary and Financial Institutions Forum (OMFIF) discussed CBDC’s potential to create an integrated and interconnected financial system. Although costly to develop, CBDCs offer cost efficiencies that outweigh many drawbacks. The OMFIF explains handling physical cash is often associated with high costs and inefficiencies. Retail CBDCs, which are available as a 24/7 payment system with instant settlement, can reduce costs by removing counterparty risk. 

A key benefit to CBDCs is their ability to provide financial inclusion to the unbanked or underbanked. In developing countries, access to traditional banking services is often limited due to a lack of infrastructure and the high costs associated with banking services. As Forbes and the OMFIF explain, CBDCs provide a cash alternative and may make it easier for people to access financial services and participate in economic activities. 

What’s Next?

Readers can look forward to articles delving into:

• The differences between privately issued digital assets and CBDCs;
• Retail and wholesale CBDCs;
• The various designs CBDCs take – token and account CBDCs;
• Implementing CBDCs in developing versus developed economies;
• The drawbacks of CBDCs;
• In-depth discussions on where CBDCs are currently being investigated. 

Disclaimer: This article is provided for informational purposes only. It is not offered or intended to be used as legal, tax, investment, financial, or other advice.