Central Bank Digital Currencies (CBDCs) are increasing in popularity as a faster and more efficient method of banking currency broadly accessible to the general public and institutions compared to the central bank reserves. However, the primary purpose of these coins is not to entirely replace the Fiat currency of the nation but to offer financial inclusion to those who don’t have access to or are unaware of traditional banking services. A recent report suggests that the number of CBDCs has doubled since the pandemic*, with at least five countries successfully launching their versions and over a dozen more in their late development stages. So why are these digital currencies growing in prominence with central banks across the globe? Let’s find out.

Key takeaways:

• CBDCs are digital fiat currencies, issued by the central bank of a country.
• While cryptocurrency is a permissionless form of digital currency, CBDCs are government-issued legal tender.
• Countries such as the US, Russia, India, the Bahamas, and Nigeria are either developing or have already deployed CBDC as an additional financial currency in addition to the existing fiat currency.
• CBDCs are not intended to replace traditional fiat currency. They are intended to act as an additional payment method.

What is CBDC?

The Covid-19 pandemic is a significant catalyst in the rising shift toward digital currencies, with a reported hundred and five countries constituting over 95% of the worldwide GDP currently exploring CBDCs. Fiat money is steadily losing ground as the most dominant legal tender to facilitate the exchange of goods and services. Cryptocurrency and blockchain technology innovations are actively helping shift the masses toward digital currencies and other forms of cashless electronic payment systems.

CBDCs are in many ways like fiat currencies as they boast the backing and support of the issuing government and are considered a safe form of digital currency that is not subject to the volatility that most cryptocurrencies face. To summarize, a Central Bank Digital Currency is a digital fiat currency that is free of credit and liquidity risk and is a liability to the Federal Reserve of the government. It is a legal tender directly issued by the government, which additionally acts as the monetary authority and regulatory body overseeing the integrity of all transactions made.

How are CBDCs being used today?

CBDCs are typically modelled on two variants targetting retail and wholesale purposes. While the retail variant is accessible to the general public, wholesale access is often limited to a predefined group of users. Let us explore the use cases of these variants:

• Retail

Retail CBDCs aim to provide the average consumer and businesses with the opportunity to utilize central bank liabilities through a government-led digital fiat currency. Retail digital currencies can potentially be subject to interest rates significantly lesser than that of reserve rates. It immensely supports the public by being accessible, affordable, anonymous, traceable, and available twenty-four hours a day.

Currently, there are two types of retail CBDCs; Accounts-based and digital tokens. Account-based digital currencies are, in simple terms, a type of savings account. To use an account-based CBDC, users must provide their credentials first to open an account and begin transacting just like they usually would with standard electronic transactions. On the other hand, account-based digital currencies follow a verification system where regulators verify the user credentials of transactors to facilitate safer and more efficient transactions.

CBDC tokens are government-led crypto tokens that, unlike decentralized cryptocurrencies like Bitcoin and Ethereum, are digital currencies issued by the government or central bank. Most governments are creating digital tokens to reach individuals who do not possess bank accounts and are unfamiliar with banking services. It offers a level of traceability for governments to monitor and track the movement of digital funds more clearly and implement financial policies where deemed necessary.

• Wholesale

Wholesale CBDCs, on the other hand, are mainly used by institutions to transact like they would with a bank account. Through wholesale digital currencies, institutions are provided with an account where they can deposit money and make transactions with other accounts. Governments and central banks further reserve the right to set interest rates on reserve balances and set reserve requirements for institutional compliance. Wholesale CBDCs also improve the transactional efficiency involving securities and derivatives. Through distributed ledger technology and cooperation between banking sector actors, governments can wholesale CBDCs widely used.

Is CBDC the same as cryptocurrency?

Although CBDCs and cryptocurrencies originate from the blockchain distributed ledger technology and share certain similarities, they serve different purposes altogether and are very different from each other. For starters, a CBDC is not a cryptocurrency or a stablecoin. Cryptocurrencies are forms of private money built on a permissionless decentralized blockchain network. Stablecoins are cryptocurrencies that have their value pegged to that of other assets such as fiat currencies or other cryptocurrencies. However, CBDCs are government-issued legal tenders in the form of digital fiat currencies that operate on a more centralized private permission network regulated by the central bank. CBDCs aim to provide financial inclusion to the masses by offering availability and equality in digital transactional services to individuals and businesses by providing a stable and easily accessible alternative legal tender to cash.

One of the primary differentiators of CBDCs from crypto is that CBDC transactional information is available between the sender, recipient, facilitating banks, and the governmental body that issues the CBDC. On the other hand, cryptocurrency transactions are made public on the distributed blockchain ledger and can be accessed by all. Additionally, CBDCs are less volatile than crypto as they hold the same value as that of the national currency of the issuing government.

Countries that are deploying CBDCs

A growing list of countries entering the race to actively develop or have already implemented their CBDCs typically do so to mitigate specific financial problems due to their economic conditions. For instance, a country where geographical conditions make it difficult for citizens to access banking services might benefit significantly from offering their residents the option of transacting through a digital fiat currency. A CBDC is not a single fixed concept that can instantaneously be applied to any region across the globe but requires careful research and development to suit different global economies. Here are some pioneers of CBDC implementation that have launched or are on track to launching their digital fiat currency.

• eKrona

Sweden’s central bank, the Riksbank, is well underway with the development of their CBDC, the eKrona, meant to be an alternative to their country’s fiat currency, the Krona. Upon completing the second phase of testing, eKrona has exhibited proof of concept by being able to integrate with existing banking systems to allow citizens to convert cash in their account to eKrona and vice versa and begin making transactions directly through their bank accounts.

• Bahamas Sand Dollar

The Bahamas Sand Dollar is a CBDC created by the Central Bank of the Bahamas to provide financial inclusivity to communities unfamiliar with traditional banking. One of its primary purposes is to mitigate the issue of expensive delivery costs and provide a significantly more efficient payment medium for its citizens. One of the significant features of the eKrona is its interoperability and offline functionality, where users can continue to make transactions even when faced with disrupted communications. When communications return, the Sand Dollar system updates itself to reflect all offline transactions made while communications were down.

• Reserve Bank of India

The RBI’s CBDC, announced during the annual budget at the start of the fiscal year 2022-2023, is projected to be launched by the end of 2023. The Reserve bank has planned a careful step-by-step implementation strategy in line with the country’s monetary policies for a smoother rollout. RBI’s CBDC is reportedly developing two separate CBDC systems for retail and wholesale purposes to boost transactional efficiency.

• E-Naira

On the 25th of October 2021, Nigeria became the first African country to launch its CBDC successfully. Nigeria constitutes the largest economy in Africa, making the e-Naira project a significant leap toward digital fiat currency adoption that has inspired other African countries such as Ghana to follow suit. The e-Naira CBDC project additionally placed a focus on working with central banks of countries like Singapore, Malaysia, and Australia to improve cross-border transactions.

In conclusion, the financial applications of blockchain distributed ledger technology and CDBCs are visibly gaining prominence across the world as a proven solution to mitigate several practical economic problems faced by nations limited to fiat currencies. CBDCs are pushing toward a possible paradigm shift for the entire financial ecosystem that could force the global banking industry to adapt and change its existing infrastructure to provide CBDC functionalities for its customers. As more countries are rushing to implement their CBDCs every day, overlooking the long-term worth of digital fiat currencies can hold nations back from offering citizens the best financial services possible.

FAQs

Does the US have a CBDC?

The US doesn’t currently have a CBDC, although steps are being taken to lay out a policy for the adoption of a CBDC soon.

Will CBDC replace cash?

CBDCs are not meant to replace cash but rather work in tandem as an additional payment method.

Is Bitcoin CBDC?

Cryptocurrencies are not CBDCs. CBDC tokens are government-led crypto tokens that are issued by the government or central bank, unlike decentralized cryptocurrencies like Bitcoin and Ethereum.