If you are already acquainted with the idea of cryptocurrency and decentralization, then you might not have a difficult time at all understanding the concept of central bank digital currencies. But to be able to better navigate between these two concepts, you must at least form a proper alliance with the concept backing cryptocurrencies as well as CBDCs.
When you are investing in a cryptocurrency, let’s say Bitcoin, or are going to use these to make a purchase, you are converting your fiat currency into crypto; some of the fees are taken up by the crypto exchanges that undergo the transition, and at the end of the day you are left with the crypto that you bought.
Now all these transactions remain completely anonymous and are propagated by a channel of decentralized networks and computing nodes that are actually people, and they can’t meddle with the transaction such as figuring out who bought the crypto, how much of it was bought, and what were the exchange rates that were offered. All this information remains anonymous and hidden onto the blockchain from which the purchase was made, completely secured in the form of blocks with proper hash numbers for easier navigation.
CBDCs vs. Crypto
You must know that the central bank digital currencies are the same as cryptocurrencies as these are also virtual assets, but the only groundbreaking difference is that these are issued by a central bank, and that is why they are completely centralized. If you are buying a CBDC token, you are willingly giving away all the information which resulted in the transaction, such as your name, how much of the token was bought, and to whom did you send it.
Central banks have delved into this whole developing a virtual currency of their own because they fear that the world of modern finance might be lost to decentralization, and because digital assets are getting such hype from people, they should introduce their own.
The gesture, however, is genuine, but the intent behind this, which is to support centralization, is something that people who are all for cryptocurrencies and the anonymity that it provides will never accept. At the end of the day, it is all about who you stand for, you might be willing to go hand in hand with your own financial institutions or banks that you have trusted all these years to step into the future by accepting and using their virtual currencies, or you might want to take a whole other approach with decentralized cryptocurrencies up there.
Significance of CBDCs
Don’t get the wrong impression cryptocurrencies are extremely significant in their own doing because these are the very principal assets that have laid the foundation for the modern world of finance. CBDCs, on the other hand, are basically, but a try on behalf of the centralized financial community to bring about their own version of virtual assets that could be controlled and properly transacted with proper records as such is done with conventional banking.
Cryptocurrencies, on the other hand, are simply a store of value, but their capacity to become a medium of exchange is extremely costly and, at some point, not worth it; that is why monetary authorities from all over the globe have brought forward their own version of cryptocurrencies in the form of CBDCs that could be properly managed as a form of mainstream payment option.
The introduction of Bitcoin in 2009 has laid the foundation for the modern concept of virtual currency and its significance thereafter. Bitcoin did provide a proper meaning on how one should approach the concept of digital assets. It brought forward a proper digital ledger to place and or digital subject transactions that are definitely not centralized. It was flawless, and it could also not be tampered with; this is what makes cryptocurrencies and the idea of decentralization such a strong suit among the modern world of finance.
During the COVID-19 pandemic, it became absolutely important to introduce more conventional and immutable monetary assistance to people because they couldn’t basically rely on hard paper money for the sake of making online transactions and or purchases. This is what CBDCs are going to solve, bringing people more than one option in terms of choosing how they want to interact with their financial life.
China at the moment is experimenting with a digital counterpart of its Fiat currency and is allowing people to make online payments using their smartphones, but China has an extremely hard stance over the use and implementation of cryptocurrencies such as Bitcoin and has uprooted the entire network of Bitcoin mining from its grounds.
Europe, on the other hand, has also announced the development of the digital Euro and has proposed a 5-year itinerary to achieve that. It was the pandemic that acted as a trigger so that the central banks all over the globe could come up with a proper solution to make online payments more achievable and without incurring too much cost over the user.
Cryptocurrencies are not permitted in every part of the world because these are extremely volatile assets that are why many countries have already banned the use of cryptocurrencies within their bounds that is why a fiat alternative in the form of central banks digital currencies propose a solution as every government and country could launch their own CBDC on the same principle of cryptocurrency but centralized and easily manageable.
The central bank digital tokens are not merely confined to having only financial significance as these can have various forms, but this would have dedicated implications for the payment systems, the transmission of the finances, and the overall stability involved into the mix as well as the monetary policy which is involved in making sure that each and every transaction takes place in a proper and transparent way.
Concept of Money Flower
If you truly want to understand the concept of central bank digital currencies as well as for cryptocurrencies, then you have to take into account the general understanding and concept of money. That is why it is important to take this whole thing in the form of money flower, which is the depiction of money in a complete cycle such as the place from it originates, changing hands from one person to another and the ultimate platform that is running the whole thing in the form of a Venn depiction.
There are four primary components that are involved in the money flower; these are the issuer, the form such as digital or physical, accessibility, which pertains to whether the asset is restricted or generally adaptable, and or technology such as store value token or an account-based medium. The placement concept of money is always divided into two basic technologies, such as store value tokens and accounts. The concept of cash and digital currencies out there is based on tokens, but the reserve account balances and most of the commercial bank money is based on accounts.
The most elementary differentiator in this whole crusade is the type of verification that is required for the sake of exchanging tokens with respect to account-based money. It is important for the payee to be able to check the legitimacy of the payment object in the form of token-based money, but on the other hand, the accounting system relies on the authentication of the account holder by identifying whether or not it is the same user that is trying to access their account or some other culprit.
That is why proper identification of the account holder is made to ensure that nothing is out of order, and in fact, it is the same person to whom this account belongs who is trying to access it now.
If you look closely, then you would find that the central bank money is at the center of the money flower because it is printed and or regulated from a central financial space that is why the concept of central banks. CBDCs, on the other hand, are classified into three different types according to their own taxonomy.
In CBDCs, both the token-based and account-based asset forms are made available. The two of the token base variants in this regard differ conveniently from each other depending on who has success and is determined by the future use of CBDCs.
One of them is a more convenient and commonly used payment instrument that is initially intended for retail transactions, but it could also be used for other purposes of the user. The other one is basically a digital settlement token, and it has restricted access primarily to be used for wholesale payments and other settlement-oriented activities. These are known as the general-purpose tokens and wholesale-based tokens, as you will find more information about these below.
Various Types of CBDCs
To be able to get a clearer picture, it is important to understand various types of central bank digital currencies and or the general purpose for which these are used. Following are some of the most common and eccentric types of CBDCs;
As it is clear from the name, the general-purpose CBDCs actually refer to central bank digital currencies, which will be distributed for and be used by the general population, the common masses. All the offerings and transactions that take place for the general purpose are done on digital Ledger technology, and the anonymity, availability, as well as traceability, is 24 hours a day and 365 days a year.
Central banks are becoming more fond of this idea in the emerging markets because they want to have a say in the fast-growing financial technology industry and promote their own version and kind of financial technology. The paperless money system is going to be a huge hit of the future, and it is important to make necessary arrangements right from this moment; otherwise, it is possible that the future might be lost to cryptocurrencies that are decentralized and cannot be brought into any kind of control whatsoever.
A bank that keeps the reserve deposits by converting the Fiat currency and or reserves into a particular sub token, for these entities wholesale only CBDC are introduced. Banks could use the wholesale-only central bank digital currencies for the sake of increasing the efficiency of the payments and security-wise settlements as well as decreasing liquidity and counterparty credit risks.
The wholesale-only CBDCs would also act as unrestricted access digital locker, which means that the enterprise for which it was initially designed and or meant for would have all kinds of control over it. This kind of token would be able to replace the supplement central bank reserves for good.
Another pretty elementary aspect of CBDCs is that the transaction would take place directly between two parties without the need for an intermediary, much like how it happens in the decentralized world, but the only difference is going to be that this kind of transaction could be properly tailed all the way back to the sender and or unveiling the amount that was sent to the receiver as well as their address. The wholesale CBDC is going to be such an important and favored concept among the central banks because it can actually move money in bulk more cheaply and in a safer manner.
Which Countries will Use CBDCs?
COVID-19 pandemic was the only trigger that set in motion the development and processing of central bank digital currencies, and as a result, many countries continue to abide by this transition and develop their own tokens. Central banks realized with the popularity of cryptocurrencies around the COVID-19 pandemic that this is their chance right then and there, and they don’t want to miss it or be left out of it, it is the very evolution of money, and they definitely want to be a part of it.
According to the Atlantic Council, there are 81 countries that represent more than 90% of the global GDP that have considered the option of developing their own CBDC token. By May 2020, there were 35 countries that were exploring the development of CBDC tokens on a priority basis. China is well ahead of the game; it is fair to say that China has its own intentions with the idea of blockchain technology and CBDC tokens. To achieve that, it has cast all sorts of Bitcoin mining operations from the country and has made a fruitful transition to issuing digital yuan, which would act as the CBDC and a counter fiat currency.
European Central Bank, the Bank of Japan, the Bank of England, and the United States Federal Reserve are all the authorities that are currently entertaining the thought of developing their own CBDCs, preparing a proprietary framework around it, and making it happen in real-time. According to the most recent data, a kind of virtual currency or CBDC token if you may have been completely launched in five nations right now, and there are many other nations that are currently entertaining the thought of developing their own CBDCs token and giving it a final go sometime in a few years.
Major Differences Between CBDCs and Cryptocurrencies
As explained multiple times already, the concept of decentralization and that of the central bank digital currencies must not be intermingled or confused with each other, these are completely different entities having the same functional ability, and that is just about it. The major difference between CBDC token and cryptocurrency is that cryptocurrencies run on permissionless or public blockchain systems, which means that anyone with access to the Internet can get benefited from a dedicated crypto network to make transactions.
There is no identification that the user needs to undergo, but in the case of CBDC tokens, the central banks are in charge of regulating these, and these are strictly centralized. This means that any and all activity that takes place for a dedicated CBDC token is being recorded in real-time, the central bank is going to know the parties involved in a dedicated transaction, the amount that was transacted as well as other details which are completely anonymous and out of reach in the form of a public blockchain and decentralization.
The information that is made available onto a public blockchain could be read, audited, and or interacted by anyone because it is public property, but in the case of the CBDC token, only the central bank has the authority to interact with the information without disclosing it to any third party entanglements.
A public blockchain that is going to serve as a digital Ledger for a dedicated cryptocurrency has fixed restrictions embedded into it in the form of a code, and this can’t be tampered with or changed down the road; these are fixed and permanent. But in the case of a CBDC token, the central bank is in charge of developing the policies of action for these tokens, and this means that the central bank for a dedicated CBDC token can change these policies and permissions whenever they deem fit.