This November, The Fintech Times is looking to broaden the understanding of digital currencies, ranging from blockchain’s use outside of crypto to CBDCs, in an attempt to replace the notion that digital currencies are a synonym for crypto.
Today, we’re looking at Central Bank Digital Currencies (CBDCs): what they are and how they differ from fiat currencies as we know them and cryptocurrencies.
What is a CBDC?
A CBDC is, in a nutshell, a new type of currency, aiming to work in tandem with fiat currencies used worldwide. The main component of CBDCs which sets them apart is the fact they operate on a blockchain, creating a token of the country’s currency and recording all transactions of that token in an immutable way.
CBDCs are still very much in their infancy, with most countries still experimenting with the concept. Should these experiments be successful, the digital currencies could leverage frontier technologies for the development of features such as programmable money, more inclusive payments services, and more robust and resilient payments infrastructure.
Some countries have prioritised their CBDCs development, however. As noted by Coindesk, Venezuela was a pioneer in this respect, launching its own cryptocurrency, the petro, in 2018. However, the petro is plagued by problems and very few Venezuelans actually use it. Besides Venezuela, the Chinese government is probably the furthest along in creating a CBDC. It is already trialling a digital yuan across several cities.
Governments were inspired by cryptocurrencies to create CBDCs, as there was a belief that Distributed Ledger Technology (DLT) could help with financial inclusion, and take away various pain points from the current payments system. Where crypto and CBDCs vary is that no central entity can turn users away from the blockchain, whereas governments use permissioned blockchain technology to limit who can view and who can change the blockchain.
Coindesk notes, Bitcoin has a limit of 21 million Bitcoins built into the protocol, and it is very hard, perhaps impossible, to change this limit. In contrast, governments each have a central bank, which is in charge of the country’s money supply. These powerful banks choose when to remove or add money to the supply, such as to stimulate the economy in troubled times, and set national interest rates, among other tasks. These roles aren’t going to change with CBDCs.
Different types of CBDC
There are two types of CBDCs: B2C and B2B.
- The B2C CBDC is known as a Retail CBDC. Investopedia notes there are two types of Retail CBDC:
- Value- or cash-based access: This system involves CBDCs that are passed onto the recipient through a pseudonymous digital wallet. The wallet will be identifiable on a public blockchain and, much like cash transactions, will be difficult to identify parties in such transactions. According to Riksbank, the development of a value- or cash-based access system is easier and quicker compared to token-based access.
- Token- or account-based access: This is similar to the access provided by a bank account. Thus, an intermediary will be responsible for verifying the identity of the recipient and monitoring illicit activity and payments between accounts. It provides for more privacy. Personal transaction data is shielded from commercial parties and public authorities through a private authentication process
- The B2B CBDC is known as a Wholesale CBDC. This type of CBDC’s DLT expedites the transfer of money across borders, enabling the automation of cross border transactions.