A Detailed Guide on CBDC: Central Bank Digital Currencies

What is a CBDC?

A CBDC, or a “central bank digital currency,” is a virtual rendering of a country’s government backed, central bank controlled currency, as you can probably glean from the title. In other words, they can be called a national cryptocurrency. The CBDCs are also known as digital fiat currencies and digital base money. CBDC is very much a new type of currency, something quite a few countries are only testing out so far. 

CBDC was essentially a response to the hype surrounding cryptocurrencies and other virtual payment systems from central banks around the globe. The designs of CBDCs vary from country to country, especially regarding privacy, access, and the basic structure of the systems, but most central banks have chosen to build their CBDCs on a blockchain, with the aim to significantly increase transaction efficiency and lower trading charges.  

History of the Central Bank Digital Currency

Ever since Bitcoin’s launch and subsequent success back in 2009, cryptocurrencies have gained massive acclaim among investors and traders across the world. This is a trend continuing into 2021. The decentralized and permissionless structure of cryptocurrencies is the main reason they appeal to so many people, and they might be able to replace the traditional financial systems functioning under the supervision of an authority figure (such as a central bank) in near future. 

In the beginning, governments around the world didn’t recognize this threat cryptocurrencies pose to fiat money; but when Facebook launched Libra in 2019 – which is a crypto coin powered by the blockchain technology, they started to realize that a crypto launched by an organization as huge as Facebook might become a widely preferred alternative to government supervised money. This was when regulatory authorities from a number of countries first began trying to control the ever growing popularity of cryptocurrencies like Bitcoin and Ethereum. They also started to explore whether they could implement a similar technology in the existing centralized financial systems or not. 

A number of countries including China and the USA came up with the idea of the central bank backed digital currency, or a national cryptocurrency, a while later.

So, How Does a Central Bank Digital Currency Work?

As mentioned before, a central bank digital currency operates as a virtual representation of a certain country’s national fiat currency. Therefore, each CBDC unit is supposed to be a secure digital instrument, exactly the same as a paper based currency token. CBDCs can act as a mode of payment, a store of value, and an official unit of account.

A central bank digital currency is intended to bring together the best of both worlds – so they will come with the accessible and secure nature of digital currencies, and the regulated, reserve-backed, and non-volatile money circulation of traditional finance. All operations of a CBDC are sanctioned, and fully monitored by the particular central bank and government of the country, since it is after all, a national cryptocurrency.

Similar to how paper bills carry unique identification numbers, each CBDC unit will have a unique identity so they can be tracked easily, as well as to avoid the risk of counterfeit money. As a central bank digital currency is a part of the currency supply watched over by the central bank, it will also work along with various other forms of fiat money, such as bills, notes, coins, and bonds. 

Central banks across the globe have considered a variety of underlying architectures for CBDCs, and most have settled on Bitcoin’s underlying technology – the blockchain and distributed ledger technology (DLT). A blockchain is a decentralized, P2P (peer-to-peer) network that consists of virtual blocks which record all information related to the transactions performed on the chain, and are encrypted so that the recorded data can not be altered easily. As for DLT, it’s a shared database maintained by a number of nodes (participants on the network) in a distributed manner, instead of a singular authority figure. 

Now, the distributed part of DLT directly contradicts the centralized nature of CBDCs. Therefore, central banks that have chosen this tech also have to work on eradicating the security and scalability issues that come with the use of the blockchain tech and the DLT.

Categories of CBDC

CBDCs are still too new to assess how many different types of coins there are going to exist. Central banks in different countries have suggested varying levels of accessibility for the central bank digital currency. For instance, some have considered developing CBDCs that would be made available to the general populace, especially in case the use of physical money continues to lessen significantly. However, some central banks have also considered limiting the use of CBDCs to only the financial organizations that hold reserves at said banks. In case of the latter, the central bank digital currencies would aim to improve wholesale payment, clearing, and transaction settlement systems between banks.

Therefore, despite the fact that CBDCs are still at a very early stage, it’s safe to say that we’ll see at least two categories of these currencies that have already emerged:  

1. Wholesale CBDC: This particular kind of a central bank digital currency can only be exchanged between central banks and private banks. These exchanges will help increase the efficiency of transactions between these organizations, as well as allow for swifter cross-border transactions, and decrease counterparty credit and liquidity risks. The wholesale CBDC is capable of simultaneously making the wholesale financial systems we have faster and more secure. 

2. Retail CBDC: Retail CBDC is, of course, central bank digital currency for the use of the general populace; the average consumer can use it to complete payments for their regular necessities. This particular kind of CBDC is based on distributed ledger technologies like blockchain, and they offer traceability, instant availability, and anonymity. Retail CBDCs also render the intervention of a third party absolutely unnecessary, decreasing the chances of any criminal activities.

Which Countries Have Introduced Central Bank Digital Currencies So Far?

As of March, 2021, CBDCs have only been proposed by central banks in several countries, and nowhere have they yet been implemented at a large scale, beyond trial runs. Most countries have only begun to explore the potential of CBDCs, like the US. However, China with its digital yuan is already way ahead of its contemporaries, already having launched pilot programs and research projects to understand the viability and usability of the central bank digital currency. 

However, China is not the only pioneer when it comes to deploying CBDCs. The BoE, or the Bank of England was the very first central bank to propose a central bank digital currency. Following on the heels of BoE was China’s People’s Bank of China (PBoC) and the Bank of Canada (BoC). Their proposals to initiate CBDCs were tralied by the central banks of Uruguay, Thailand, Venezuela, Sweden, and Singapore, among many others.

Interestingly, Venezuela already launched a national cryptocurrency- the petro – in 2018. Petro was said to be backed by physical stocks of crude oil. However, petro has proven to be a failure so far; it deals with several issues and very few Venezuelans make use of it. 

As for China, so far it’s the country furthest along in developing a fully functional central bank digital currency. By October 2020, China’s digital yuan had gone through the biggest pilot scheme for CBDCs till date, which spanned several cities. Reportedly, in the southern city of Shenzhen, the PBoC gave away 200 yuan (which amounts to about $29.75) each to 50,000 consumers selected at random through a lottery to spend in selected stores. The trial run also incorporated the most used lifestyle apps in China. 

In the United States, the U.S. Federal Reserve Bank of Boston, in collaboration with the Massachusetts Institute of Technology (MIT), is experimenting with its own national cryptocurrency – a digital dollar, as well. However, they are still very much at a contemplative stage, and the digital dollar is probably not going to be a reality at any point in the near future.  

Coming to Russia, Vladimir Putin had announced the crypto-ruble back in 2017, and it’s assumed that they are still moving forward with its development. However, according to speculations, Putin was only interested in CBDCs because of the underlying blockchain technology, which would facilitate encrypted transactions and make it possible to send money discreetly without risking sanctions being placed on the country by the international community.

In Europe, the European Central Bank (ECB) has stated in a report that they have started working on a digital Euro, and are considering and researching its usability as both retail and wholesale currencies.

As for the central banks in other countries, the Bank of Canada partnered with six other central banks including the Bank of England, the Bank of Japan, the European Central Bank, the Federal Reserve Bank of Boston, Sveriges Riksbank, the Swiss National Bank, and the Bank for International Settlements to publish a report on the foundations of central bank digital currencies. However, Canada has not yet decided to experiment with a national cryptocurrency of its own. The Swiss National Bank, on the other hand, is enthusiastically considering creating a national CBDC. As of March, 2021, they have collaborated with the Bank for International Settlements to test a central bank digital currency soon enough. 

India’s Steps Towards Introducing a Central Bank Digital Currency:

Finally, coming to India, very recently on 25 January 2021, the Reserve Bank of India (RBI) announced that it is exploring the need for a central bank digital currency in India. The Lok Sabha Bulletin Part II states that The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 will be introduced by the Government of India during the Budget session of the Parliament, and it will propose to ban the trading of private cryptocurrencies like Bitcoin or Ethereum. It will also provide the Reserve Bank of India (RBI) with the legal authority to develop a CBDC.

Aside from the urge to make new-age, digital financial products so India can be on the same page as countries like China and the USA, there’s another incentive for the Indian government to develop a national CBDC: there’s still a vast expanse between the number of bank accounts and mobile phone connections in India, and a central bank digital currency might become the bridge we need.

Aside from helping the RBI in taking a huge step closer to complete financial inclusion, the digital rupee would also bring about a cashless society, and decrease the cost of printing and handling fiat money by a large margin. The introduction of a digital rupee would empower the citizens and the government alike by expanding the digital economy, and do away with the inefficiencies of the current banking system.  

And that was all the important tidbits you might want to know regarding a central bank digital currency! We do hope you found our post on these national cryptocurrencies informative!

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