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What is CBDC? The Ultimate Guide on Central Bank Digital Currencies

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The future of money is changing and it is changing quickly. The recent surge in interest in central bank digital currencies or CBDCs for short is a good example of that. The concept is fairly new, but already enjoys serious interest from some of the most consequential financial bodies in the world, including the European Central Bank (ECB), the US Federal Reserve, and the International Monetary Fund (IMF).

The list goes on and it includes the Bank of England (BoE), the People's Bank of China (PBoC), and others. CBDCs are just another representation of traditional FIAT currencies, with the added benefits of benefitting from blockchain technology that hopefully will lead to better control, transparency, and accountability of the global money supply.

CBDCs have the added upside of being backed by suitable monetary reserves such as gold or foreign currencies, leading to better stability for these new centralized tokens, and certainly better than any other blockchain currency presently on the market.

What Are CBDCs?

CBDCs are a centralized blockchain alternative to FIAT money. Instead of storing money physically or trying to muster a better physical monetary medium, banks are now exploring the option of having everything transferred digitally, with the help of blockchain and the underlying Distributed Ledger Technology (DLT).

Put simply, CBDCs are the digital representation of FIAT money, and they serve the exact same purpose as regular currencies, such as USD and EUR. The difference is that they are digitized versions of the former, still controlled by central financial authorities, usually the central banks.

image of stacks of bitcoin (BTC) coins

Another important mark of a CBDC is that it is backed by financial reserves, such as gold or other currencies. This allows CBDCs to benefit from the transactional power and reduced costs of maintenance and operation that cryptocurrencies have.

At the same time, the CBDCs' value is not subject to sudden changes, as the respective monetary authorities are in control much the same way they control a country's regular money supply.

CBDCs are also designed as multi-faceted solutions, and they can be used as a payment option, as a way to store value and a unit of account. To avoid fraud, CBDCs have a unique serial number, and, thanks to the DLT, imitation and falsification will be beyond the reach of even the most advanced perpetrators.

Put very simply, CBDCs are a solution that leverages the security and convenience of a digital currency and combines it with the regulated status and stable pricing of a central bank currency. When CBDCs first arrive, they will be used as part of the regular money supply, including coins, bills, bonds, and notes, but in the future, they are expected to completely supplant these, as they become digital or are dropped completely due to redundancy.

Why Are Countries Considering CBDCs Now?

CBDCs should in theory bring in better transparency and accountability, as well as potentially bring better overall stability in the global financial system. One proponent of the quick digitalization of money is the Bank of England governor, Mark Carney, who last year urged nations to come together and seek a way to replace the domineering position of the US dollar.

Instead, Carney expects the dollar to be supplanted by a digital currency backed by a league of nations that will make global trade less prone to the mood swings of the US economy, as he argued during an annual gathering of the central bankers in Jackson Hole, Wyoming, Powell.

Apart from the self-evident benefits of the DLT, the world is now looking into CBDCs for much the same reason consumers are turning to cryptocurrencies. A CBDC should supposedly offer slightly more leeway against the dominance of the US dollar, and create a more level playfield for participants, according to Carney. However, upending the global financial system is not something that can be carried out easily, nor is it safe enough in the first place.

Until recently, the US Federal Reserve has been reluctant to broach the topic of digital currencies, but many calls have been heard for the United States to start investing more time and effort into the digitization of money lest it loses its preeminence in the global financial system. Meanwhile, central banks have already been joining forces to study the case for digital currencies.

The administration of President-elect Joe Biden may seek to change tact and pay more attention to the digitization of money. Treasury Secretary Steven Mnuchin and Federal Reserve Chairman Jerome Powell have said there is no need to do as of right now.

Who Has or Is Building CBDCs Today?

Reliance or overreliance on the US dollar has prompted many nations to seek a way out. Incidentally, nations hit by US sanctions have been some of the pioneers to scramble for financial mechanisms that allow them to circumnavigate these restrictions.

North Korea has supposedly been stealing funds and converting money into various crypto tokens to avoid detection. Venezuela introduced El Petro, buffeted by its worst financial crisis to date and in 2017 Russia revealed plans to develop the digital ruble.

Clearly, CBDCs would give the country that yields them some leeway and lack of dependency on a financial system still dominated by the US dollar. However, politics is not all that it will take to embrace digital currencies.

Today, the number of countries dashing for the digital finishing line is growing, and the majority of countries have genuine reasons to want and adopt CBDC.

image of jeans back pocket with credit cards stacked inside

Among those pushing for a digital currency are the Bank of England, the European Central Bank, the Bank of Canada, Sweden, and Singapore's central financial regulators, and many others. The PBoC has already debuted its own digital currency, the e-yuan, which is still in development but shows great promise to supplant any traditional currencies.

China has been a leader in mobile payment innovation for years now, partly because of the state's overreach in the personal life of its citizens, but also thanks to the many promising startups that have facilitated payments.

A Chinese centralized digital currency makes a lot of sense in a country that has already gone digital in much of its financial system.

Are CBDCs Different Than Cryptocurrencies?

The main difference between cryptocurrencies and CBDCs is the centralization model. The DLT used in Bitcoin decentralized control over the supply. In fact, the only way to gain full control is to own at least 51% of the supply, which is highly unlikely due to the high resource demands to pull something like that off.

On the other hand, CBDCs are going for a centralized model which according to many cryptocurrency pioneers is the opposite of what crypto should do. Nevertheless, there are distinct benefits of centralized currency.

Cryptocurrencies often rely on ill-defined stability factors. In fact, whales can dump and buy supply at such a pace that it crashes the valuation of Bitcoin overnight, plummeting its value and dashing all hopes of quick monetary return.

However, with a CBDC, these valuation fluctuations will no longer be the case as the actual worth of a currency will depend on a central monetary reserve, which stabilizes the price. Besides, thanks to DLT, central banking authorities will be able to control the supply as well as authorize other particles to participate and run it.

Conclusion: Are CBDCs the Future?

CBDCs hold a fantastic promise for the future of money. They are centralized, transparent, and accountable. Governments will surely have a little more to say in what happens to the money in general, but they do this right now.

Just because we own money physically doesn't mean that we are free of the same level of governance from a central banking body. While many would argue that cryptocurrencies are the way to be independent and free of the meddling of big government, the case for CBDCs remains very strong.

CBDCs can be an ultimate equalizer whereby financial fraud becomes much harder to pull off and eventually traceable to the guilty party or parties on an expedited schedule. Slashing fraud, bringing in transparency in finances is the right way towards the future.

A lot of this will ride on the successful implementation of CBDCs which can work well in big monetary unions, such as the European Union, or countries with sizable populations such as Russia, China, or the United States.

Ultimately, though, if CBDCs become the norm, a new global system will be established, and there are no guarantees that this transition will go smoothly.

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