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Central Bank Digital Currency (CBDC): In-Depth Guide in 2024

Central Bank Digital Currency (CBDC): In-Depth Guide in 2024Central Bank Digital Currency (CBDC): In-Depth Guide in 2024

Central bank digital currencies (CBDC), also called digital fiat currencies, or digital base money, are a form of digital money issued by a government central banks for household and business use. CBDCs are not meant to replace cash and bank deposits but to coexist as additional payment methods.

China aims to launch e-CNY digital currency during the 2022 Beijing Winter Olympics. UK, Canada, and France are also investigating in blockchain technology to optimize banking processes rather than for a digital coin.

What is a central bank digital currency (CBDC)?

Central bank digital currencies (CBDCs) are a digital form of the currency issued by a central bank. They are regulated by a country’s monetary authority, and are implemented using a database which is controlled by the central bank, government, or authorized private-sector entities.

CBDCs are available in 2 forms:

Account-based

Account-based CBDCs, previously described as central bank electronic money, work just like regular deposit accounts. The user is required to set up an account with which they can perform transactions, as well as send and receive digital currency. A transaction requires accessing the users’ information to verify the ID of the sender and receiver.

Digital tokens

Tokens were previously described as central bank cryptocurrency. Token based systems involve the transfer of an object of value from one wallet to another. In traditional financial systems a token can be a banknote or a coin, and in cryptocurrency a token is a bitcoin for example. Digital-token-based-systems do not require the user to verify their identity to send or receive a payment. However, the transaction is approved based on public-private key pairs and digital signatures between the sender and receiver.

Common challenges that face digital token based systems which allow anonymity are

  • lack of identity requirements. This can facilitates the risk of money laundering and fraud
  • when you lose your token, you lose access to your assets. This has happened to many crypto coin investors. However, users are now more accustomed to using tokens and this is less of a problem compared to the past.

Another type of digital tokens is the non-fungible tokens (NFT) which represent digital assets in contrast to bank digital tokens which represent currency. To learn more, feel free to read our in-depth article on NFTs.

What are CBDC use cases?

Currently CBDCs are built for either retail or wholesale payments.

Retail CBDC

Retail CBDCs are used in the same manner as banknotes, to make payments between individuals, or between individuals and businesses. Retail payments are carried out via banknotes, cards, and online transactions. Public users can have retail CBDCs in the forms of deposit accounts and/or digital tokens.

Wholesale CBDC

Wholesale CBDCs are used to enable transactions between financial institutions and entities that have accounts in central banks. According to the Bank of International Settlements (BIS), wholesale CBDCs can:

  • improve the development of capital markets
  • enhance cyber security
  • provide improvements in securities trading and settlement

What are the pros and cons of CBDCs?

With the rise of blockchain technology and cryptocurrency, central bank digital currencies (CBDCs) are gaining increasing popularity among global financial institutions. If implemented correctly, CBDCs can have the following pros & cons for the financial system:

Pros

Central bank digital currencies (CBDC) can significantly change the financial services by facilitating the accessibility as well as the usage of fiat currency. The main benefits of CBDCs are:

  • Allowing real-time monitoring and analytics of all the finances running through the central bank
  • Enhancing the efficiency of central banking systems
  • Enabling faster and easier transactions via mobile applications
  • Reducing costs of financial services by:
    • limiting the printing of banknotes
    • eliminating physical cash distribution and destruction from circulation

Additionally, compared to crypto coins, CBDCs can be more broadly accepted by the general population because they are subject to legal and government regulations. They do not have the stigma of being preferred by those who want to avoid detection by authorities.

Cons

CBDCs face some challenges due to the economic situation within a country in addition to other reasons, such as:

  • Widespread adoption challenges: Increased digitalization may leave a portion of society behind due to potential barriers around trust and data privacy, digital knowledge, and access to IT. For example, the central bank of Ecuador launched retail CBDCs in 2014. However, the program stopped due to low citizen adoption.
  • Cyber risks: Defending against cyber attacks will be more difficult as the number of endpoints in a general purpose CBDC system will be significantly larger than those of current wholesale central bank systems.
  • Cross-border payments: CBDCs can facilitate cross-border and cross-currency payments independent from work-hours and holidays in different time zones. However, different legal and regulatory frameworks present a significant obstacle to cross-border payments. Harmonizing these frameworks would be a challenge.

What are the beneifts of CBDCs for end users?

Important benefits are reduced burden of cash handling and risk of financial intermediaries failing.

CBDCs are similar to other forms of mobile payment applications from a user perspective. So for a Chinese user, the benefits are similar to using Alipay for mobile payments or investment. For the user, important point is adoption. If there can be universal adoption for CBDCs, then CBDC adopters may forgo using cash altogether which saves them from keeping cash on themselves which requires regular trips to the ATM or bank.

Whenever you use a mobile payment app, a credit card or any other type of digitalized money, there is risk that the financial institution providing the infrastructure may fail. That is why governments provide protection for deposits for example. However, these protections are only limited. Relying on the central bank rather than the financial institution would remove an intermediary and reduce risk of bankruptcy of your financial solution provider. However, there is always some risk, governments (e.g. in Russia and Argentina) have also failed on their commitments in the past.

What is the difference between CBDC and cryptocurrency?

There are 3 important aspects to currencies:

  • Money creation: monopoly or competitive
  • Representation: physical or virtual
  • Transaction handling: centralized or decentralized

For example,

  • Cash is a monopoly created physical currency which is transacted in a decentralized peer-to-peer manner.
  • CBDCs (aka. central bank cryptocurrency) can be viewed as a virtual version of cash.

CBDC and cryptocurrency are both a type of currency enabled by blockchains. However, the main differences between CBDC and cryptocurrency are:

  • Money creation:
    • CBDCs are legally owned by governments or a very limited number of individuals (e.g. El Salvador bank was founded as a private company). On the other hand, the cryptocurrency approach focuses on democratizing financial systems.
    • CBDCs are created by central banks, whereas cryptocurrencies enable users to create money with the help of a consensus algorithm. Therefore, money creation is controlled by the consensus algorithm and the participants in the consensus process. Money creation process may involve proof of work (i.e. completion of a complex work package) or proof of stake (i.e. users stake to receive new money in a process moderated by the consensus algorithm).
  • Representation: Both CBDCs and cryptocurrencies are virtually represented assets.
  • Centralization: CBDC transactions still have to go through the banking system, whereas crypto relies on peer-to-peer transactions with no middle man.
  • Other: Both CBDCs and cryptocurrencies’ market price changes based on supply and demand and therefore the beliefs of market participants about the current and future value of these currencies. A CBDC’s worth should be directly linked to the governments’ treasury value and the fiat currency prices. Crypto’s value should rely on its utility within a certain blockchain ecosystem.

How will CBDCs impact cryptocurrencies?

Adoption is key in rolling out any currency and minimizing alternatives can increase adoption. Some countries that aim to minimize capital flight and have CBDC programs have taken restrictive steps against cryptocurrencies. For example:

  • China: Chinese regulatory authorities, which are working on developing the e-CNY, imposed a ban on initial coin offerings (ICO) in 2017 and termed cryptocurrency transactions “illegal”. That ban triggered an instant 6% decline in bitcoin prices.
  • India: Indian authorities have one of the strictest laws on cryptocurrencies which criminalize the possession of crypto assets, trading, mining, or transfer. This law was announced in 2018.
  • Turkey: Turkey’s central bank banned the use of cryptocurrencies in payments for goods and services in April 2021.

While we are not aware of prosecuted individuals because of cryptocurrency holdings because of these bans, platforms have suffered as a result. For example, the users of a cryptocurrency platform based in Turkey are having trouble accessing their assets. As much as $2 billion could be lost as a result of the founder leaving with the funds after the ban.

Which countries have adopted CBDCs?

To date, live CBDCs such as the Sand Dollar so far have had limited but promising adoption. In addition, The U.S, China, Russia, Japan, and the UK are launching programs and research projects to investigate the validity and usage of CBDCs.

According to Deloitte:

  • ±60 central banks are researching CBDC adoption and effects
  • 36 banks are considering retail and wholesale CBDCs
  • 18 banks are considering only retails CBDCs

CBDC examples

Ranked based on project maturity, wholesale projects are led by:

  1. Thailand and Hong Kong: Project Inthanon-LionRock
  2. Singapore: Project Ubin
  3. Canada: Project Jasper
  4. UK: Cross-border interbank payment and settlements
  5. France: Digital Euro
  6. South Africa: Project Khokha
  7. Europe: Project Stella
  8. UAE: Project Aber
  9. Japan: Project Stella

On the other hand, retail projects are led by:

  1. The Bahamas: Project Sand Dollar
  2. Cambodia: Project Bakong
  3. Mainland China: e-CNY
  4. Ukraine: e-Hryvnia
  5. Uruguay: e-Peso
  6. Ecuador: Dinero Electronico
  7. Eastern Caribbean: DCash
  8. Sweden: e-Krona
  9. South Korea: e-Won
  10. Turkey: Digital Lira

Bahamian dollar sand dollar

The Sand Dollar project started in late 1990s, and the CBDC was launched in October 2020 as a digital version of the Bahamian dollar. The Sand Dollar project is aimed to address the issue of the widespread of the Bahamas over 700 islands which made it difficult to implement ATM systems.

However, the adoption is still very minimal, with only $130,000 worth of sand dollars in circulation compared with $500 million Bahamian dollars.

e-RUPI

Indian e-RUPI is not a full fledged currency but a digital voucher mechanism in the form of SMSs or QR codes for transferring benefits to citizens. Users will be using these vouchers to purchase goods or services at retail locations that accept them. Institutions that helped set up e-RUPI include: National Payments Corporation of India (NPCI), National Health Authority, Ministry of Health and Family Welfare and Department of Financial Services.

Success of e-RUPI or its implementation challenges could shape Indian government’s views about launching a CBDC.

Further reading

To get a better idea about the blockchain technology, feel free to read our articles on the topic:

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Cem Dilmegani
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Cem Dilmegani
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Cem has been the principal analyst at AIMultiple since 2017. AIMultiple informs hundreds of thousands of businesses (as per similarWeb) including 60% of Fortune 500 every month.

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Throughout his career, Cem served as a tech consultant, tech buyer and tech entrepreneur. He advised businesses on their enterprise software, automation, cloud, AI / ML and other technology related decisions at McKinsey & Company and Altman Solon for more than a decade. He also published a McKinsey report on digitalization.

He led technology strategy and procurement of a telco while reporting to the CEO. He has also led commercial growth of deep tech company Hypatos that reached a 7 digit annual recurring revenue and a 9 digit valuation from 0 within 2 years. Cem's work in Hypatos was covered by leading technology publications like TechCrunch and Business Insider.

Cem regularly speaks at international technology conferences. He graduated from Bogazici University as a computer engineer and holds an MBA from Columbia Business School.

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2 Comments
Tariq Shaikh
Dec 17, 2021 at 03:09

This is a good primer for anyone looking to get started.

No2CBDC
Nov 29, 2021 at 08:43

Interesting article. The real reason for CDBCs we all know is the complete visibility and control of currency so tyrannical governments can further enslave their citizens particularly when it comes to the “programmability” of CBDCs – ie the use of them can be specified very precisely in terms of use and location and even have an expiration on them. Not much benefit to the citizens but wonderful for enforcing the level of tyranny and mass surveillance control never before seen in history! CBDCs should be opposed and resisted at all costs! Cash is king and needs to remain so.

Bardia Eshghi
Nov 18, 2022 at 07:35

We’re glad you enjoyed the article. Everyone’s got their own opinion, right? 🙂

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