What is Central Bank Digital Currency (CBDC), and How is CBDC different from Cryptocurrency

In this article, we’ll talk about Central Bank Digital Currency (CBDC) and how it differs from cryptocurrencies. A CBDC is a digital currency that a central bank backs and issues. The world’s central banks have realized that they must offer an alternative or risk missing out on the money of the future as cryptocurrencies and stablecoins have grown in popularity. Thousands of digital currencies, often known as cryptocurrencies, already exist. The most well-known completely decentralized Cryptocurrency is Bitcoin.

Stablecoins are a different kind of Cryptocurrency whose value is tied to an asset or a fiat currency, such as the dollar. Cryptocurrencies operate via distributed ledger technology, which means that numerous devices throughout the globe, rather than a single central hub, continuously check the integrity of the transaction. But this is distinct from when a central bank issues virtual money.

Central Bank Digital Currency
Photo credit: Central Bank Digital Currencies (CBDCs): A Crisis Recovery Tool For Governments

What is Central Bank Digital Currency (CBDC)?

The digital version of a nation’s fiat currency representing a claim against the central bank is known as a Central Bank Digital Currency. The central bank provides digital currencies or accounts that are protected by the full confidence and credit of the government rather than creating money. Digital tokens, similar to cryptocurrencies that central banks issue, are known as central bank digital currencies.

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They are linked to the value of the fiat money used in that nation. Numerous nations are developing Central Bank Digital Currency (CBDCs), and some have even put them into practice. Understanding digital currencies and what they signify for society is crucial because many nations are looking at how to transition.

A government-issued currency, fiat money, is not backed by a tangible thing like gold or silver. It is regarded as a type of accepted legal money for the exchange of goods and services. Banknotes and coins served as the traditional forms of fiat money. Technological advancements have made it possible for governments and financial institutions to replace the physical form of fiat money with a credit-based system in which balances and transactions are recorded digitally. Although physical currency is still extensively accepted and exchanged, its use has significantly declined in several wealthy nations, a tendency that increased during the COVID-19 epidemic.

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More people are becoming interested in cashless societies and digital currencies due to the development of bitcoin and blockchain technologies. Government-backed digital currencies are thus being investigated by central banks and governments worldwide. When and if they are adopted, these currencies would be fully trusted and supported by the government that produced them, just like fiat money.

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How is CBCD different from Cryptocurrency? 

Cryptocurrency is a decentralized digital asset and medium of trade built on the blockchain. Controversy has been stirred up by its decentralized nature, which refers to its operation without a mediator like banks, financial organizations, or central authority. The ecosystems of cryptocurrencies offer a glimpse of a different type of monetary system where transactions are not subject to onerous laws. They are difficult to copy or forge and are protected by consensus processes that thwart tampering. Digital currencies issued by central banks are intended to resemble cryptocurrencies, but they might not require blockchain or consensus systems.

Cryptocurrencies are also decentralized and uncontrolled. Their worth is determined by user interest, usage, and investor reaction. They are speculative-oriented assets more prone to volatility, making them improbable choices for a financial system that demands stability. CBDCs are intended for stability and safety and reflect the value of fiat money.

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Types of CBDCs

Central Bank Digital Currency (CBDCs) come in wholesale and retail. The primary users of wholesale CBDCs are financial institutions. Customers and businesses like that utilize retail CBDCs as physical forms of money.

 Wholesale CBDCs

CBDC wholesale transactions resemble keeping reserves in a bank. An institution receives a bank account from the central bank to deposit money into or utilize to complete interbank transfers. Then, central banks can control lending and set interest rates through monetary policy instruments like reserve requirements or interest on reserve balances.

 Retail CBDCs

Retail CBDCs are digital currencies the government supports and utilizes by consumers and companies. Retail CBDCs minimize intermediary risk or the possibility that private digital currency issuers could go out of business and forfeit their clients’ assets. Retail CBDCs come in two different flavors. How each user accesses and uses their currency varies:

  • Both private and public keys are required to access token-based retail CBDCs. Users can carry out transactions anonymously thanks to this validation technique.
  • For account access in account-based retail CBDCs, digital identification is required.

 

FAQs

Is CBDC a Cryptocurrency

CBDCs are not cryptocurrencies, even though cryptocurrencies and blockchain technology inspire the central bank digital currency concept. While cryptocurrencies are virtually usually decentralized, meaning a single authority cannot govern them, CBDCs are managed by a central bank.

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Is CBDC Based on Blockchain?

Blockchain need not, but it is an option for CBDCs. In their research, the Digital Currency Initiative at Michigan Institute of Technology and the Federal Reserve Bank of Boston discovered that distributed ledgers might impair a CBDC’s effectiveness and scalability.

Conclusions

According to the European Central Bank (ECB), which plans to implement a digital euro across its 27 member states by mid-decade, CBDCs are “a risk-free form of money that is backed by the state.”

According to the Bank of England, because CBDCs are linked to a nation’s official currency, they lack the volatility of privately created digital currencies like Bitcoin, Ether (Ethereum), and XRP.

The Federal Reserve of America claims that if a CBDC were to be launched, it would be “the safest digital asset available to the public, with no associated credit or liquidity risk.”

What do you think about Central Bank Digital Currency (CBDC), and how is CBDC different from Cryptocurrency? Say your thoughts in the comment section below.

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