A central bank digital currency is a digital version of a fiat currency issued by the central bank of a particular country. They have similar components to cryptocurrency; however, their value is determined by the CB and is usually equivalent to the country’s traditional currency.

Currently, many countries are on the verge of developing their CBDC, while some have even implemented theirs, including China. In other words, CBDC is becoming a trendy concept in the global economy, hence the reason you need to understand what it entails.

In this article, we will discuss the types, merits, and demerits of CBDC as well as some frequently asked questions about the unique digital money. Without further ado, let’s dive in.

Types of CBDCs

CBDCs can be categorized into two types, namely, wholesale and retail CBDCs.

Wholesale CBDC

This form of CBDC usually targets Financial Institutions as its primary consumers. It is just like storing reserves in the central bank (CB). When an institution deposits funds in its account, CB can leverage the monetary policy protocol, like reserve requirements, to set interest rates and lending conditions.

Retail CBDC

This is a form of CBDC aimed at businesses and individual investors. Retail CBDC is backed by the government and helps to eliminate third-party risks —a case where a custodian collapses and loses all customers’ funds. Retail CBDC is of two types:

Token-based retail CBDC: can be accessed with private or public keys or both, enabling customers to validate transactions anonymously.

Account-based retail CBDC: this retail CBDC can only be accessed with digital identification.

It is noteworthy that both Wholesale and Retail CBDCs can interoperate in a single economy.

Merits of CBDCs

The Federal Reserve has pointed out some of the critical financial issues CBDCs address, which are stated below.

No credit and liquidity risk

CBDC eliminates the role of third parties in transactions, thereby eradicating common transaction risks, including bank failures and bank delays. Hence, stories of multiple customers losing their funds due to a bank’s collapse won’t be heard of again.

Reduces cross-border payment costs

The central bank-issued digital currency has the potential to drastically reduce the exorbitant cross-border transaction fee by facilitating regional cooperation between countries and eradicating complicated distribution systems.

Financial inclusion and expanding public access

CBDCs provide financial inclusion for both the banked and the unbanked as they annul the cost of operating an economic structure in a nation, lowering the entry barrier for the public to benefit from its potential. It also creates a direct connection between central banks and users.

Anti-money laundering and anti-terrorist funding

With the implementation of CBDC, it would be easier for the government to monitor the transactions of individuals and institutions and thereby control the rate of money launching and terrorist funding in the country.

Demerits Of Issuing A CBDC

Privacy and protection

Fighting money laundering and terrorist funding are two key reasons the Feds push for issuing CBDCs, as they would have direct access to customers’ transaction data. However, while this is good, it is a significant issue as it enables the government to breach customers’ privacy rights, a concept which the decentralized would hold dearly.

Cybersecurity

Another big deal with the CBDC is that once launched, it would become a prime target for internet hackers and bad actors who have been rampaging the digital finance system, aiming to steal investors’ hard-earned funds. This implies a need for a more robust security system if CBDC issuance eventually materializes.

Financial system stability And Monetary policy influence

The issuance of a CBDC would result in a significant change in the financial system structure when this happens, the impact it would have on the stability of the financial system, as well as the monetary policy concerning lending, inflation, spending, and interest rates, still remains to be seen.

FAQs

Difference between Crypto and CBDCs?

While Crypto and CBDCs are similar, they have unique differences.

Cryptocurrency provides a decentralized financial space where no one is in charge, making it difficult for transaction records to be destroyed or tampered with as consensus mechanisms control them. Meanwhile, CBDCs do not use consensus mechanisms and are controlled by the government.

Will CBDCs replace fiat currencies?

Well, even though digital money is trending amongst countries, fiat currency would still exist, as some people would still prefer their funds in cash.

Conclusion

Currently, about 130 countries are working on their central bank digital currencies, which about 11 nations have already deployed, including China. This shows that the world is rapidly welcoming the idea of the CBDC, and in no time, many countries will have issued theirs.

Generally, CBDC is a great innovation, however, it can be a powerful surveillance tool in the hands of the governments to monitor the flow of money and transaction details of an individual or company. Hence heavily reaching the privacy rights of people.