In time, this new digital currency might grow more than cryptocurrency
While the cryptocurrency hype shows no signs of dying down, CBDCs are making headlines as the next big thing. Short for ‘Central Bank Digital Currencies,’ this is a new form of digital currency planned by monetary authorities like the central banks. The legitimacy of cryptocurrencies is an open debate where traditional financial institutions are against cryptocurrencies. To dull down the speculations of unregulated cryptocurrency leading to a global financial catastrophe, monetary authorities hope to use blockchain technology to their advantage, while maintaining regulatory authority and stability through CBDCs.
Understanding a CBDC
Traditional currencies issued by central banks like the dollar, euro, rupee, etc, work in a similar way, fundamentally with monetary policies that are unique to every country. Central Bank Digital Currencies will also function in the same way. Ideally, a CBDC will be a digital token representing the virtual form of a fiat currency of a particular country. The major difference between a cryptocurrency and a CBDC will be the fact that these tokens issued by central banks will have some degree of centralization, so that central banks can control the money flow for the objective of economic growth and financial stability. To back up a CBDCs valuation, a suitable value of monetary reserves like gold will be pegged to it.
Regular payment methods like cash, cards, and bank transfers serve a purpose in our society. While cryptocurrency was initially created to become another mode of legitimate payment, eliminating the former, it is only being seen as an investment option for the time being. So, how will CBDC cater to different demands?
According to the Bank of Internation Settlements (BIS), there will be two types of CBDCs, wholesale CBDCs, and retail CBDCs. The wholesale type will only be accessible to a predefined group of people whereas the retail variant is for general purpose.
CBDC Developments So Far
The majority of wholesale CBDCs will be restricted to financial institutions in order to be used for interbank payments. On the other hand, retail CBDCs is the one that citizens can hold and use for digital payments. According to reports, retail CBDC projects are being accelerated in emerging economies.
The Chinese CBDC project is the most leveraged one. Launched in April 2020, China has made concrete developments with its ‘digital yuan’. Estimates suggest that approximately, US$23 million worth of digital yuan is currently in circulation. By the time the 2022 Winter Olympics commences in Beijing, The People’s Bank of China aims to increase the domestic use of their CBDC.
The US is not behind in this race. The Digital Dollar Project (DDP) is a non-profit partnership between Accenture and the Digital Dollar Foundation, that plans to launch five pilot programs within the span of one year. The status of this project is that currently, the authorities are experimenting with whether a digital dollar would actually survive in an advanced economy where fast digital payment modes already exist. However, the US will launch the Digital Dollar at the right time to become the world’s reserve currency.
The Pros and Cons
Similar to cryptocurrency, one major benefit of CBDCs is that the emerging method will reduce the high cost of transferring cash. In emerging economies, CBDCs will also allow people who cannot access banks to get easier and safer access to money.
However, the cons outweigh the pros. Governing authorities are already at the receiving end of backlashes when it comes to attempting to regularize cryptocurrencies. The same can be the case with CBDC as it carries additional cybersecurity risks. Some central banks might even be lacking the technology to deal with a new form of money.
While central banks have a lot to figure out to launch their own CBDCs, it still holds the potential to kill cryptocurrencies. China has already imposed a ban on crypto trading and investments with the aim to promote the use of its digital yuan. When other governments follow suit, the current cryptocurrency hype might dull down.
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