Inspired by the concept of crypto, Central Bank Digital Currency (CBDC) is a currency issued digitally by the central bank of a sovereign country.
In other words, CBDC is not destined to follow the phenomenon of decentralization unlike the concept of crypto, and what is more, it is regulated.
However, this new form of digital currency will use technologies such as blockchain in its mode of operation.
Having a fixed or variable value, depending on the currency to which it is attached, the CBDC, just like fiduciary money, can be used in transactions by individuals as well as institutions.
So why are governments and banks, in general, increasingly interested in CBDCs?
Beyond the security, speed and transparency of transactions, there are other factors that lead these institutions to consider an CBDC program.
The rise of Bitcoin and decentralization, the response of central banks with CBDCs
In the late 2010s, Bitcoin and other crypto’s are booming. And with this, the very spirit of distribution and exchange of value is called into question, along with the decentralization movement.
This idea that it is no longer central banks or institutions that should control all transactions.
In addition to the emergence of a crypto community, the DIEM episode will accelerate things. DIEM is the digital currency developed by Meta (Facebook), before 2020, which aims to enhance the user experience.
The problem is that institutions and central banks have in front of them one of the biggest DATA companies in the world, reaching over 3 billion users.
As a result, DIEM will face a number of hurdles as it moves toward release, some of which are related to regulations.
In the meantime, it was renamed LIBRA, and the problems followed: price stability, confidence from large investors and legitimacy.
Little by little, the project will lose its allies (PayPal or Ebay), and in November 2020, the prospects are reduced to end up being backed by the US dollar.
Thus, we have here, the example of a virtual currency, functioning as a crypto, but which would be managed and controlled by Meta. In fine, a beautiful project, which shows the premises of the CBDC, but which will lose its interest at this time.
However, forced to note that Bitcoin and crypto are more than established, and having already considered the issue of a digital and stable currency, states will launch several test programs.
And that solution is CBDC (Central Bank Digital Currency).
Distinctions between CBDC and crypto: centralization, regulation and backing to an existing currency
The main distinction is in their ethics and their mode of operation.
CBDCs are issued by the state as a centralized form of digital currency, while crypto-currencies are decentralized digital currencies, meaning they are not issued by a central authority.
Yes, CBDCs can use blockchain technology, but their centralized form sets them apart.
Thus, central banks can control and regulate the creation, distribution and value of CBDCs, which is not the case for crypto.
And then CBDCs are generally going to be backed by an existing fiat currency and have a fixed or variable value relative to that currency, whereas crypto has a value determined by supply and demand in the crypto markets.
The different categories of CBDCs: use, mode of operation and technologies used
If we do not have the exact number of CBDCs that were created day by day, it is possible to classify them according to several categories.
- How they are used: for retail or wholesale transactions, or for interbank transactions. They can be issued as account currencies, which are held by commercial banks as a form of reserve money, or as payment currencies, which can be used directly by consumers and businesses.
- CBDCs can also be classified according to their mode of operation, such as distributed account system, centralized or decentralized systems. In addition, CBDCs can be based on different technologies such as blockchain, DLTs, open-source technologies and other similar technologies.
Today, although the classification is a bit fuzzy, it is important to remember that CBDCs are considered money because they are issued by central banks and used as a means of payment.
Example of CBDC
While there are no officially issued and used CBDCs in the world today, more than 60 central banks and institutions are trying to establish programs for the future:
- China’s Central Bank (CB) is working on an CBDC program called DCEP (Digital Currency Electronic Payment), which has already been tested in some cities across the country. 🔔 On this point, issues of traceability and control of expenditures are raised .
- The Bahamas CB launched a pilot of its CBDC in 2020, called Sand Dollar, which is currently being tested.
- The Cayman Islands CB is working on a project called Project Sand Dollar, which should be launched soon.
- The Bank of France launched an experimental CBDC program in March 2020, which aims to explore the potential uses of this technology.
- The Bank of England has established a working group to explore the possibilities of creating an CBDC.
- The European Central Bank has also announced that it is studying the possibility of creating an CBDC for eurozone citizens. ♻️ See below on this last point.
Why CBDCs are increasingly developed by institutions: reasons and benefits
There are many reasons for this.
1/ Restore economic activity: by using innovative technologies to carry out transactions (blockchain, DLT…etc), CBDCs can be redistributed directly by central banks to individuals and companies in a faster, less expensive and more secure way.
2/ In times of economic crisis: central banks could thus help governments to provide targeted aid to certain areas or groups of people.
3/ Improve the traceability of transactions: these could be traced, with the possibility of updating in real time the results of an economic activity.
In summary: speed, efficiency of transactions, stability of economic activity, the possibility of acting better in a hurry, transparency of exchanges and cost reduction.
🔔 Of course, these are the reasons, from an objective point of view.
Ecology, an angle to compete with private companies on the development of a green CBDC
Outside of regulatory cases, central banks and institutions are becoming aware of the challenges of the digitization of money and new technologies, with a strong trend towards decentralization.
Within the framework of the EU, the issue is being studied in the direction of the fight against global warming. Thus, the idea currently discussed would be to create an account named “CO2 account”, an account fed with euro-green, a CBDC that rewards the efforts of citizens.
The concept is still under consideration and would be as follows: as soon as emissions or efforts made to this effect are recorded, a Euro-Green will be issued. For example, if a citizen buys an electric bike or a bicycle.
One can imagine the complexity of implementing these measures on a national scale, and moreover, on a European scale. However, this could come to give CBDCan appeal, to possibly stand out from some crypto.
In a nutshell
- CBDCs are digital currencies issued by the central banks of a sovereign country and can use blockchain technology in their operation.
- Central banks can control and regulate the creation, distribution and value of CBDCs, which is not the case for crypto.
- CBDCs can be classified into several categories, including their use, mode of operation, and technology used.
- More than 60 central banks and institutions are currently working on CBDC programs, such as the DCEP in China, Sand Dollar in the Bahamas, and the Sand Dollar project in the Cayman Islands.
- Ecology is also an angle to compete with private companies, with the idea of creating an account called “CO2 account” that rewards the efforts of citizens in the fight against global warming.
- The advantages of CBDCs are speed, efficiency, transparency of transactions, stability of economic activity, the ability to act better in a hurry and cost reduction.