CBDCs can often leave people feeling perplexed due to their unfamiliarity with the underlying technology. The utilization of blockchain as part of this technology can further add to the confusion. It is common for individuals to assume that CBDCs are a form of cryptocurrency, but this is actually a misconception.
It is just like your normal currency, like the dollar, but in digital form. This article will provide a profound knowledge of how CBDC works and the benefits and challenges of this technology. Let's dive in!
How Does A CBDC Work?
Central Bank Digital Currency (CBDC) is a digital version of a country's currency. This is the digital representation of fiat money, issued under the complete control of a country's central bank. The traditional form of currency usually exists in physical form. It might be the long existing coins, or it might be in the form of paper. However, the new CBDC offers the digital representation of coin or paper currencies.
There are significant differences between fiat currency and CBDC, including their form and technology. Fiat currency is physical and issued by a country's central bank, while CBDC is digital and used for online payments and complex financial tasks, like investing.
Additionally, fiat currency is completely anonymous and untraceable, whereas using CBDC leaves traces of financial activity and spending.
What Are the Characteristics of CBDC?
Here are some major characteristics defining Central Bank Digital Currency (CBDC).
CBDCs are programmable, meaning that the government or the central bank can easily modify them to function exactly how they want. For instance, the central bank might program a CBDC initiative to function within certain payment needs and locations.
Digital Form and Stability
One major characteristic of CBDCs is that they operate digitally and have no relationship with the physical world. One of the benefits here is that users can easily make payments online using their mobile devices instead of waiting for cash. To operate in a digital form, CBDCs function within a digital ledger or blockchain. This makes the transactions to be more transparent and secure.
Furthermore, the digital ledgers used here might be a blockchain or not. An excellent example of a digital ledger is the XRP Ledger, which powers the CBDC initiative of many countries. Another characteristic of CBDC is its stability, which cryptocurrencies can't boast of.
Many people do not use the bank due to the stress and the often expensive processes of managing several bank accounts. CBDC often provides a direct link through which people can access the financial ecosystem from the central bank.
What Are the Challenges of CBDC
There are many problems associated with CBDC, and this is why many people don't want to use this type of technology for their day-to-day activities.
The impact of CBDCs on cryptocurrency is not significant because of the technology's difficulty with privacy. Cryptocurrencies offer the advantage of maintaining anonymity, but this is not the case with CBDCs. The government can easily track the exact amount and purpose of transfers made through this technology.
The majority of the crypto industry is decentralized; the same can't be said about CBDC, where a country's central bank has complete control of every data and resource.
Issues with Cross-border Payment
In some cases, it is much easier to use and convert fiat from your country to another country than to use CBDC. This is because the central banks of countries usually limit the usage of this technology within their country. Furthermore, there are many legal and regulatory hurdles to pass before a cross-border payment with CBDCs can exist between two countries.
Countries Adopting CBDC
The majority of the countries that are adopting CBDC usage are primarily from the Asian continent. China is the major country that has gone very far regarding CBDC by introducing its digital yuan.
According to the latest data, around 130 countries, representing over 98% of global GDP, want to create their own CBDC. These countries are mainly divided between those who are already implementing CBDC and those who are still exploring.
For instance, China is in full throttle of using this technology while the United States is still researching and testing the technology.
Some examples of countries strongly advocating the use of a Central Bank Digital Curriency are Hong Kong, the UAE, Australia, Singapore, Malaysia, China, and many others.