Because they are decentralized and largely unregulated, cryptocurrencies have exploded in popularity over the past 11 years since the creation of Bitcoin. Investopedia defines central banks as “a financial institution given privileged control over the production and distribution of money and credit for a nation or a group of nations.” This makes them a threat to central banks.
The newest buzz centers around central banks wanting to develop their own digital currencies or cryptocurrencies because they are unable to control the influence and growth of cryptocurrencies. Some governments are debating it, while others have already begun working on it.
What is CBDC?
A central bank digital currency, or CBDC, is said to use digital tokens and blockchain technology to represent the official fiat currency of a nation or a region in a digital format. In contrast to decentralized cryptocurrencies like Bitcoin and Ethereum, a CBDC is centralized. This implies that it will be governed by a nation’s or a region’s monetary institution.
It’s interesting to note that the concept of CBDCs existed prior to the creation of Bitcoin, according to the bank for International Settlements (BIS).
There are more than 20 years involved!
Why Are Central Banks Interested in Issuing Digital Currencies?
The main reason is financial inclusion for everyone, especially those who are unbanked, such as those who live in rural areas and are unable to access banks or ATMs. CBDCs can be made available to anyone with a smartphone – similar to the availability of cryptocurrencies.
Another factor to look at for why central banks want to create their own digital currency is Facebook and its Libra token. While the Libra token isn’t released yet, Facebook’s announcement sent shockwaves among policymakers, as they have 2.6 billion active users – all of whom could become Libra users. Compared to Bitcoin’s global adoption rate of less than 5%, the volume of Facebook’s user base sure is something that could create a big shift.
Opportunities and risks of CBDCs
There have been numerous discussions about the opportunities and risks that CBDCs bring as numerous nations worldwide are either considering or working on them. Recently, the BIS collaborated with seven significant central banks from around the world to produce a report outlining the guiding principles and essential characteristics of CBDCs. The document was made public on October 9, 2020.
CBDC VS Cryptocurrency
And just so you know, despite the fact that both CBDC and cryptocurrency are digital assets and share some similarities in their concepts, CBDC actually contradicts what cryptocurrency is all about.
Centralized vs Decentralized
While cryptocurrency is decentralized, CBDC is centralized. CBDC will be governed by the monetary authority of a nation or area, also referred to as one central network. Contrarily, cryptocurrency is managed by the numerous distributed nodes that receive rewards for the upkeep of the network.
The blockchain has flaws, but cryptocurrency has at least partially addressed security issues. According to Blockchain News, CBDCs “are likely to be cyber-attacked by rival states who now have to deal with one centralized point of failure for financially motivated hackers to attack”.
Are Central Banks Planning to Issue Their Own Digital Currencies?
Things appear to be in flux at the moment. Even though the creation of a CBDC has not been decided upon, the report they produced with the 7 largest central banks, “Central bank digital currencies: foundational principles and core features,” is a significant advancement.
Any newly established CBDCs will be required to adhere to:
- “Do no harm” – CBDCs should ensure financial and monetary stability and not obstruct central banks from carrying out their mandates.
- Live side by side with cash, bank notes, and other forms of money to enable a varied, creative, and adaptable financial ecosystem.
- Encourage efficiency and innovation, and actively involve the private sector.
The BIS and the major central banks of the world want to build on the enthusiasm and dedication currently surrounding CBDCs. Before central banks issue any CBDCs, it has been noted that a number of policy facets and underlying assumptions need to be thoroughly investigated.