A central bank digital currency (CBDC) is basically a digital version of regular money. It gets its status as money from government rules.
The way a CBDC is designed will probably differ quite a bit depending on the country that issues it. Some might use blockchain or another kind of distributed ledger technology (DLT), while others might just rely on a centralized database. The ones that are blockchain-based will use a token to stand in for the digital version of fiat currency.
While it’s true that CBDCs might take some cues from cryptocurrencies like Bitcoin, they’re actually pretty different. CBDCs are created by a government and recognized as legal tender.
On the other hand, cryptocurrencies like Bitcoin are global and not tied to any government or central authority. That said, you can still make international payments with a CBDC, but Bitcoin doesn’t even recognize national borders.
A lot of central banks are looking into or even testing out CBDCs as a proof-of-concept.
China has been developing a project called DC/EP, which stands for Digital Currency/Electronic Payments, since 2014. They’ve already started active trials for the digital yuan in several cities. Meanwhile, the European Central Bank (ECB) released a report in October 2020 that suggested a digital euro and evaluated the benefits of such a digital currency.
Understanding about CBDC
From a tech perspective, a CBDC is basically a database that’s managed and overseen by the government (or maybe some approved private sector entities). That’s why it’s considered a permissioned database, since only authorized players can make transactions on the network.
Because of this, the centralized body that controls the database can also stop transactions from happening, reverse transactions, ‘freeze’ funds, or put certain addresses on a blacklist.
Most CBDCs will likely operate on their own blockchains. However, some might be launched on public blockchains. This would allow for permissioned assets to be settled on a permissionless base layer. It could offer the best of both worlds, where the permissioned layer gives central banks the control they need, while the permissionless layer ensures top-notch security.
That said, this probably won’t be the standard practice. Right now, no public blockchain has the tech capabilities or has been around long enough to reliably handle such a crucial role.
On top of that, it’s a bit tricky to give a general overview of how a CBDC functions, since each country will take a different route. They’ll likely customize the technology to fit their unique requirements.
The Benefits
You might have come across the term “banking the unbanked” when talking about cryptocurrencies. While it sounds good, CBDCs might actually do a better job at this than decentralized currencies like Bitcoin. If every legal citizen can easily access a low-cost bank account, it can really boost financial inclusion.
Another plus is the tech improvements that revamping the money system can bring. A lot of fiat money is just numbers in a database, but much of the infrastructure is pretty old-fashioned. Sending an email on a Sunday afternoon takes just a few seconds – and it should! But because of our complicated financial system, sending money can take several days.
During the economic responses to the COVID pandemic, we’ve realized that central banks need to move quicker than ever. CBDCs could allow central banks and financial institutions to make changes in monetary policy more directly than before. This could really change how central banking operates.
Plus, a CBDC makes it simpler for governments and central banks to monitor illegal activities.
Conclusion
To sum it up, central bank digital currencies are basically a digital version of regular money. A lot of CBDC projects will probably utilize blockchain tech, making it easier for everyone to handle digital payments.