CBDC stands for "central bank digital currency," a new type of currency that governments around the world are experimenting with. What sets CBDC apart from traditional currencies is that proponents hope it can use a new payment technology, usually blockchain, to potentially increase payment efficiency and lower costs.

This new type of currency is still in its early stages of development. Most countries are still just beginning to explore the idea, such as the U.S. form of the digital dollar. Several ambitious countries, including China with its digital yuan and South Korea, have already completed demonstrations and are testing the technology. But CBDC has yet to show itself to the world on a large scale.

Each country exploring CBDC has a different approach. Several CBDCs are based on the same general principles and blockchain technology behind Bitcoin, which is a major cryptocurrency.

Why a CBDC?

If a country issues a CBDC, its government will treat the digital currency as legal tender, just like fiat currencies. Digital currency and cash would be legally recognized as a form of payment and would act as a requirement for the central bank or government.

Digital currency increases the security and efficiency of both wholesale and retail payment systems. With regard to wholesale, a central bank's digital currency facilitates rapid settlement of retail payments. It can improve the efficiency of point-of-sale or two-party (p2p) payments

If a country intends to become a cashless society, digital currency supported by the government or central bank is a credible alternative. There is strong pressure on governments to adopt CBDC as the private e-money market is on the rise.

In addition to domestic transactions, the current model of payments between jurisdictions, relies heavily on central banks operating a real-time gross settlement infrastructure (RTGS) in which all local bank obligations must be met. Because there are time lags in cross-border payments, the parties involved are exposed to settlement and credit risk. In the case of CBDC, however, it is available around the clock, with confidentiality taken into account.

The different types

CBDCs are divided into two different offerings depending on the target users:

Retail.

Retail CBDC, based on distributed ledger technology, is trackable, anonymous and available around the clock. It also offers the ability to apply interest rates. With these advantages, the retail CBDC digital currency is targeted in particular to support the general public. It also helps reduce the cost of printing cash and promotes financial inclusion.

Wholesale CBDC.

Wholesale CBDC improves the efficiency of payments and security settlements by solving liquidity and counterparty risk issues. It's great for financial institutions whose reserves are held at the central bank. Because of its ability to improve the speed and security of wholesale financial systems, even central banks consider wholesale CBDC a preferred alternative to existing systems today.
The distinction from cryptocurrencies

Digital currency is created and managed by a country's central bank. Moreover, it is implied as official means of payment, unlike Bitcoin and other cryptocurrencies.

CBDC is issued by the country's Central Bank. The bank has the tools to regulate transactions with the national currency. Work with CBDC is based on the principle of centralization, resulting in a single supervisory authority.

Decentralized cryptocurrency, such as Bitcoin, are outside the direct influence of economic and other regulators. Central banks are unable to monitor the issuance, promotion, and use of such digital assets.

Unlike digital currency, the value of cryptocurrencies is not secured by reserves. The introduction of CBDC into circulation has significant implications, not least because it will eventually displace cash from circulation.

The Central Bank's attitude to digital currency

According to experts, the improvement of digital currency is one of the significant trends in the monetary field that will dramatically change the world of cash in the coming decade.

According to the BIS, as of January 2020, more than 80 percent of CBDCs were being studied and upgraded.

A report released by BIS in April 2020 confirms that the COVID-19 pandemic has only accelerated development in this area. According to the report, China, Sweden and Canada dominate digital currency development.

Compared to 2019, the number of speeches in which CBDC executives were interested in various CBDC factors has increased.

While a couple of years ago, public statements by central bank governors and board chairs about digital currencies were predominantly negative, especially with regard to retail CBDCs, the rhetoric began to change in late 2018. At this point in time, central bank governors seem to view CBDCs more positively than negatively.

Advantages and disadvantages

Advantages

CBDCs make the process of implementing monetary policy and government structures easier. They automate the process between banks through wholesale CBDCs and establish a direct link between consumers and CBDCs through retail CBDCs. E-currencies can also reduce work for the rest of government systems, such as the distribution of benefits or the calculation and collection of taxes. CBDCs can establish a direct link between consumers and the Central Bank, thereby eliminating the need for ultra-expensive infrastructure. Also, digital currencies can prevent illegal activity because they function electronically and do not require serial numbers to control them.

Disadvantages of

CBDCs do not necessarily solve the problem of centralization. The central authority (the central bank) is still responsible for conducting transactions. Thus, it still controls data and transactions between citizens and banks. Also, users will have to give up some degree of privacy. The provider will become aware of every transaction that takes place. This could lead to privacy issues similar to those that haunt tech giants and Internet Service Providers (ISPs).

Conclusion

Given the considerable effort and attention the CBDC is devoting to this topic, digital currency will soon become a reality. The introduction of CBDCs around the world will help stimulate the adoption of cryptocurrency, as people will have access to platforms to convert cryptocurrencies into legitimate tenders. Moreover, it will also help in expanding access to financial services to the unbanked population.

CBDCs will have far-reaching implications for the future of finance, including the buying and selling of digital assets and securities. However, the question is, when? That answer will rest on the foundation of a dedicated legal framework to facilitate transparency, distribution and issuance of the digital form of money by governments around the world. As regulators and central banks take concrete steps toward establishing CBDCs, the world will begin to accept digital currencies as a standard.