What Is CBDC? Which Are the Countries Experimenting With It?

The concept of CBDC

CBDC (Central Bank Digital Currency) is a new class of currency that different governments worldwide are observing. The main difference between CBDC and regular currencies is that the first one is designed to run innovative payment solutions, especially a blockchain in order to make financial operations more efficient and low cost. So, a CBDC represents the digital form of a fiat currency of a particular nation (or region). It is centralized as the competent monetary entity of the country issues and regulates it.

CBDC is still in the early stages of its development. Most countries began doing research. The USA formed a digital dollar. Some countries went further. For instance, China with its digital yuan and South Korea, have already completed a demo and are testing the technology. But a CBDC has yet to be expanded. For many years the traditional banking system has faced difficulties in controlling the increasing influence of leading blockchain-powered crypto assets such as Bitcoin and Ethereum.

These cryptocurrencies have got huge demand due to their decentralized and regulation-free features. They even become a threat to the current banking structure that runs under the scope and control of a country’s supervisory body, such as a central bank. Not being able to control the expansion and impact of crypto assets, many leading central banks all over the world are currently working on releasing their own variants of cryptocurrencies.

Also known as digital fiat currencies, CBDC will function as a digital reproduction of a country’s fiat currency and will be backed by a corresponding amount of monetary supplies like gold or foreign currency reserves.

Each CBDC will function as a secure digital means similar to a paper bill and can be practiced as a form of payment, a store of value, and an official part of the account. Such as a paper-based currency note that carries a unique accession number, each CBDC unit will also be identifiable to prevent copying. Since it will be a part of the reserve funds controlled by the central bank, it will run alongside other forms of regulated money, like coins, bills, notes, and bonds.

The main goal of CBDC is to combine the best features of crypto and fiat. It will represent a unit that is as convenient and secure as cryptocurrencies and also is regulated and reserved-backed. It's something between BTC and state-issued banknotes. The particular central bank or other competent monetary authority of the country will be the only one responsible for its operations.

How are CBDCs different from crypto assets?

CBDCs differ from other digital currencies as they are issued by government agencies and are attached to fiat currencies. A lot of countries are currently working to find out if CBDC will be able to bring benefits to their economies. Although DLT has some things in common with cryptocurrencies, the objects are not the same. Ethereum and other public blockchains are special as no central power or group of organizations (as is the situation with DLT) control them. That’s generally not a quality that meets the governments' requirements.

Governments are preferring DLT technology because it allows taking charge over particular features like:

The stores: BTC has a limit of 21 million bitcoins evolved into the system, and it is extremely difficult, even impossible, to break this number. On the other hand, each government has a central bank, which administers the country's money flows. They decide when to withdraw or extend capital to the stocks, such as to boost the economy in difficult times and arrange national interest rates, among other functions. These duties aren't subject to change.

Who regulates it? A central body will vote which financial institutions participate in running the distributed ledger. This contrasts with Bitcoin, which permits anyone to manage the software, without authorization.

On the other hand, a permissioned blockchain allows access only to selected entities. It's up to those entities to decide who can reach the blockchain and what operations they can do with it. One user would be able only to read the blockchain, while another to read and modify it.

What are the benefits and challenges of CBDC?

One important thing that CBDC brings is financial inclusion. This means to reduce global poverty. Access to a bank account can be difficult in some countries. CBDC comes to adjust legislation and establish definite rules on the use of cryptocurrency. So, unbanked people will be able to legally transfer their funds through a cryptocurrency wallet by the internet. They can get their job payments in crypto. This way people's financial inclusion will increase.

Cost and time-efficient: Digital currency payments have the ability to be sent almost instantly from a sender to a receiver at a part of the cost of a regular (international) bank payment. The implementation of CBDC would facilitate more cost and time-efficient settlements of cross-border financial transactions.

Security of the payment policy: Several central banks are worried that the payment system is controlled by a few very big companies (including foreign ones). In such circumstances, some central banks find CBDC as a possibility to improve the flexibility of their trading system.

Despite these potential benefits, CBDC can face various challenges. One of them is the risk of running. During difficult financial situations, people tend to withdraw their bank accounts and get material banknotes. In a digital money environment, the number of withdrawals might grow immensely as they provide simple and fast transactions. Besides, an immediate launch of CBDC can create a bank run, of people desiring to switch money for e-money, which can cause a problem, with banks not bearing enough cash to meet the withdrawal orders.

Global implications: CBDC of major currency countries available internationally could raise currency substitution (“dollarization”) in countries with raised inflation and unstable market prices. These cases require further study, along with the possible impacts on the global financial system.

All countries will have to analyze the advantages and disadvantages of the case for CBDC connecting with their individual situation.

Which are the countries experimenting with the idea of a CBDC?

A study by the Bank for International Settlements (BIS) from January 2020 shows that 80% of worldwide central banks are engaged in CBDC-related research. The idea of CBDCs belongs to the Bank of England (BOE). Still, the first country issuing CBDC became the Bahamas.

On October 20, 2020, the Bahamas introduced the first-ever nationwide Central Bank Digital Currency in the world sand dollar.

China is another leader in this aspect. Perhaps, the most advanced of the several initiatives that are being developed around the world belongs to China. Central banks, including the People’s Bank of China (PBOC), have been working on the digital yuan program since 2014. Some crucial aspects like an estimated launch timeline remain undisclosed. Further testing was announced to take place during the Winter Olympics in 2022.

Uruguay, Thailand, Venezuela, Sweden, Singapore, Russia, and many countries are studying the possibilities of launching a central bank-issued digital currency. Venezuela has been working on a CBDC called the "petro" since 2017, which would be backed by material stocks of crude oil (petroleum). The Venezuelan government also announced "petro gold" in 2018, allegedly pegged to the value of oil, gold, and other precious metal.

Conclusion

The interest in CBDCs is growing. This has several reasons. Interestingly, a too dominant role of cash in the payment system, as well as decreasing cash usage, are mentioned as motivating factors. On the one hand, the CBoB and the RMI address inefficiencies from high cash usage and aim to promote financial inclusion with a CBDC. China and Sweden, on the other hand, see the importance of declining cash usage and stress negative implications of lower cash usage as a motivation for their CBDC.

Other reasons are better surveillance (CBoB), eased internationalization of the currency (PBoC), and creating an alternative source of revenue (RMI). Concerning their implementational design, CBDCs are quite similar. With the exception of the SOV, all projects would rely on a two-tiered operating structure, and none of them is planned to bear interest. However, these initiatives follow different approaches for CBDC limits, anonymity, offline usability, international access, and technology.

Note that the impact of a CBDC on the financial system could so far only be theoretically analyzed. Therefore, it remains to be seen how citizens would, in fact, react to the concrete implementation of a new variant of central bank money. Given the advanced status of the presented projects, we might soon be able to observe this reaction.