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Like cryptocurrencies, central bank digital currencies (CBDCs) are virtual assets intended to store funds and transfer value among parties. However, while cryptocurrencies are typically associated with decentralized infrastructure, CBDCs are issued by nations’ central banks as digital equivalents of their fiat currencies.
What are Central Bank Digital Currencies (CBDCs)?

Consider the US dollar. It's issued by a government that assures its value, but this hasn't always been the case. Originally, dollars were backed by gold, meaning every dollar in circulation was guaranteed by physical gold reserves. However, the Great Depression's economic turmoil led the U.S. to abandon this gold standard domestically in 1933, and globally in 1971. Since then, the dollar's value depends on the U.S. economy's strength, foreign currency reserves, and trust in the government itself.

As technology has matured, the use of cash (i.e., fiat currency bills and coins) has declined considerably, in favor of credit cards, transaction networks like Automated Clearing House (ACH), payment apps, and other virtual forms of exchange. Although people can transfer value using these tools, behind the scenes, banks still need to operate using traditional mechanisms. As fully digital versions of fiat currencies—issued by governments’ central banks—CBDCs serve as digital forms of cash and update the ways transactions are processed by institutions.

In 2020, the Bahamas became the first country to launch a CBDC, called the Sand Dollar. Other early entries included the e-Naira (Nigeria), JAM-DEX (Jamaica), and Digital Rupee (India).

Benefits of CBDCs

Proponents of CBDCs argue that government-backed digital assets represent a natural evolution of money. In the developed world, increasingly fewer daily transactions use the physical cash minted and printed by nations’ central banks. Therefore, as virtual equivalents of fiat currencies, CBDCs would match the demands of 21st century finance.

There are two main types of CBDCs a government can issue: wholesale and retail. While some models keep them separate, others incorporate both into one system, creating a third “hybrid” type of CBDC.

  • Wholesale CBDCs are currencies available to financial institutions (like commercial banks) who have accounts with the central bank. They are intended to be used in large-scale transactions and settlements between institutions. The theoretical benefits of using a CBDC include the speed at which transactions can be finalized (current systems like the SWIFT messaging system can take up to 5 days) and the low cost of doing so. Wholesale CBDCs could also provide a means of more easily controlling economy-scale liquidity in times of financial stress.
  • Retail CBDCs serve the general population rather than institutions. These are more like the cash that one may carry around in their wallet or purse. They can be used for payments with merchants and between holders—without the intermediaries that we have become accustomed to. Some believe that retail CBDCs also may be a way to give those who are “unbanked” access to financial tools.

Criticism of CBDCs

Although updating the current fiat currency system to meet modern technological demands is appealing, CBDCs are not without controversy.

First, some worry about privacy concerns. If the government can track every digital asset it issues, then private transactions could theoretically be uncovered without the consent of individuals. Also, there is the possibility that if the central bank can facilitate transactions using its proprietary assets, the role of commercial banks is considerably compromised. Furthermore, while cash cannot be programmed, digital assets can. This means governments can technically limit how CBDCs are spent by individuals. These concerns are not guaranteed to become reality, but they highlight the need for ethical and responsible policies to guide the implementation of CBDCs worldwide.

CBDCs vs. cryptocurrencies

CBDCs are digital assets equivalent in value to fiat currencies and issued by central banks. Although they keep a stable value equaling the US dollar, the euro, or other monies, they are not “stablecoins” by a typical definition, as they are issued by governments themselves and not by a third party. There may be different types of CBDCs within a country (e.g., wholesale and retail), and each country issues its own. Additionally, CBDCs may be based on blockchain technology, but the network on which they operate is centralized and closed to public management—except through the democratic voting process in the country.

Cryptocurrencies are digital assets secured by cryptographic processes, often on a blockchain, and they typically rely on decentralized public networks. Communities develop cryptocurrencies in a collaborative fashion, and decentralized governance gives crypto holders a direct voice in their directions. The first cryptocurrency was Bitcoin, but others like Ethereum have followed and developed into innovative technologies that go beyond the storing and transaction of value.

Summary

  • Central bank digital currencies (CBDCs) are digital assets equivalent to fiat currencies. They are issued and controlled by governments’ central banks.
  • Three main types of CBDCs exist: wholesale CBDCs (for use by institutions), retail CBDCs (for use by the general public), and hybrid CBDCs (incorporating utility of both wholesale and retail versions). They are intended to update the current uses for cash and traditional payment rails.
  • Even though CBDCs are digital assets and may be based on blockchain technology, their designs are significantly different than established cryptocurrencies like Bitcoin and Ethereum.

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