What is a Central Bank Digital Currency (CBDC)? How’s it Different from a Cryptocurrency

2021/05/31 14:47:41

From Britain to the Bahamas, the world's most prominent banks are getting in on the act of issuing digital cash to fend off potential threats to traditional fiat currency while offering seamless approaches to making payments.

Most, if not all central banks see the spread and wide adoption of cryptocurrencies as a threat to their tenets and activities alike. As such, they are experimenting and researching digital currencies.

This article covers the basics of Central Bank Digital Currencies (CBDCs), an overview of some critical features relative to cryptocurrencies, and a brief comparison of crypto assets digital currencies. Let’s delve right into it.

CBDC = Electronic Form of Cash

In essence, CBDC is an electronic form of cash. It uses digital tokens or electronic records to portray a virtual type of traditional/fiat currencies for a specific country or region. Similar to conventional cash, this form of digital currency offers its holders a direct claim on central banks and enables individuals and businesses to carry out e-payments and transactions.

CBDCs are centralized, as only the authorized monetary authority of a specific country has the right to issue and regulate its activities.

Comparing CBDCs to Some Aspects of Cryptocurrency

We can compare central bank digital currencies to various aspects of cryptocurrencies in order to determine in which ways they are similar, and in which they differ.

Decentralization - Decentralization is one core feature that drove almost every individual into the cryptocurrency ecosystem. Essentially, it is the most crucial and first key feature of crypto assets. However, this is absent in CBDCs. CBDCs have a central authority that governs their distribution and activities. They are issued and managed by central banks of respective countries whose blockchain network interaction and accessibility are only available to particular financial institutions with necessary requirements.

Transparency - We all know how difficult it is to know how much bitcoin a person owns, but still, everyone knows, from the ledger, the specific amount of transactions an address made, as well as the recipient address of such transaction. Blockchain offers an elegant framework for cryptocurrency to ensure maximum transparency in its dealing. However, CBDCs are also built for total transparency, which poses a looming risk.

Governments regulate their activities, and as such, have complete control over it all. Full transparency will only strengthen governments’ power further. Now, they will not only have maximum control over issuance but also access to everything you do with your money. This idea implies that we are transparent to the government, hence, prone to manipulation and control.

Anonymity - Needless to say, users of cryptocurrencies can remain anonymous or pseudonymous, and there's (almost) no chance of tracking a transaction back to them. This is because owning a cryptocurrency doesn't require you to fill up any legal papers that may help identify when needed. This has been the primary concern of government over the years, and undoubtedly, it is one of the fundamental tenets that birthed this development.

Different from having full control over your crypto wallet, CBDC holders will have their identities tied up to their bank accounts, implying an equal amount of information tied to the digital currency as the traditional bank account. So, when you make transactions, banks will have unrestricted access to your basic information such as email address, legal papers, phone number, physical location, and more. Besides, they will also have a good record of time, amount, and even the tiniest details you can imagine.

Blockchain - blockchain technology is arguably the most remarkable and revolutionary innovation over the past few decades, if it is implemented alongside systems such as decentralized consensus mechanisms. Cryptocurrencies are mostly decentralized digital assets hosted using permissionless or public blockchain technology and a network that anyone can access. This denotes that no central authority can limit its use. CBDCs’ blockchain is very different from the one we all know about. It is permissioned and private, and as such, a central authority can regulate and control access to it at will.

Use cases - CBDC use case is only limited to payments and other monetary transactions. It doesn't extend to speculative purposes. Fundamentally, CBDCs are built for wholesale and retail payment. A retail CBDC is the digital form of cash, while the wholesale variation signifies a new framework applicable for interbank settlements.

In essence, the retail version is used for payments between businesses, individuals, and other transactions, just like digital banknotes. Usually, retail CBDC’s daily volume surpasses 100,000,000 transactions. On the other hand, the wholesale form primarily facilitates interbank settlements, which signifies payment between entities that account at the central bank. Usually, its daily volume is less than a hundred thousand transactions.

Digital Currencies vs. Cryptocurrencies: The Fundamental Conflict

Every cryptocurrency is a digital currency - the ultimate premise behind a crypto asset is its existence in digital space and a digital ledger. However, not every digital currency is cryptographic by default, and this is where most people get confused.

A transaction that is carried out via a digitized medium doesn't denote that it is decentralized. Fiat currencies, of every form, are still bound to regulations. However, cryptocurrency, even as a digital currency, is not attached to any regulatory body.

Essentially, what this whole comparison infer is that cryptocurrencies are digital currencies, but not all digital currencies are cryptocurrencies. Digital currency is a broader sense that encompasses every form of transaction carried out using a digitized medium, whether centralized or decentralized.

CBDC is Not a Cryptocurrency

Now that we understand the basic features and tenets of CBDCs and how digital currencies are not necessarily cryptocurrencies, it is rational to clarify a significant doubt about CBDCs. Many individuals generally assume that CBDCs are just another variant of crypto assets. As mentioned before, CBDCs have central banks at the heart of every one of its transactions and can only be available for use in account-based or token variants.

Several individuals still wonder whether CBDCs will be available instantly with cash-like liquidity or a significant lifespan. While these questions are still unanswered, in the long term, banks will perceive CBDCs as a payment scheme option. Most importantly, it is essential to know that they are not cryptocurrencies, but rather a form of centralized digital cash.