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Central Bank Digital Currency: The Future of Crypto?

The advent of the internet has unleashed a wealth of opportunities for us in terms of buying, selling, and exchanging money. We’ve come a long way from the days of bartering systems and gold coins. These days, money flows through established financial systems that have been in place for centuries. Now, governments and banks are now turning to a new form of currency: CBDCs (central bank digital currencies). 

But what are CBDCs? Are they cryptocurrencies? What do they mean for existing financial markets? This guide will explain the ins and outs of CBDCs to explore why they’re called “the future of money.”

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What’s a CBDC?

CBDCs, or central bank digital currencies, are digital assets issued by a country's central bank. CBDCs are similar to cryptocurrencies but are pegged to the value of a country's native—or fiat—currency and are liable to that country's central bank.

CBDCs are a relatively recent trend that many countries have started developing, while some have already put them into practice. For instance, in the U.S., the Federal Reserve issues two types of money: physical currency and digital money.

A country’s central bank issues CBDCs the same way they would issue their native currency, giving it the price stability of fiat currencies while offering the ease of transaction that crypto provides.

Traditionally, most of the money in the U.S. has been held in digital forms, such as in savings accounts, digital payments, or through internet banking. A CBDC, on the other hand, is different from other types of digital currency currently used by the wider population because the central bank is liable for the CBDC rather than any commercial bank.

What are CBDCs used for?

The fundamental objective of CBDCs is to offer financial stability, transparency, transferability, flexibility, and accessibility to companies and consumers. They provide an alternative to using printed money or physical coins and bills.

CBDCs can also minimize the cost of cross-border transactions, reduce the expense of maintaining a sophisticated financial system, and offer more affordable choices to those who now transfer funds via other alternative methods.

They also provide an opportunity to offer financial services in areas where banks aren’t available. As long as someone has access to an internet connection and an IoT (internet of things) device, they can utilize CBDC facilities.

Why are CBDCs important?

Experts estimate that digital currencies issued by central banks will decrease the risks associated with adopting crypto compared to how they are today. That’s because the value of cryptocurrencies continuously fluctuates, making them quite volatile. With CBDCs, crypto users will find another way to use their coins and tokens when they want to transact.

The general stability of an economy might be impacted by this volatility, which can put countless households under significant financial strain. CBDCs will offer individuals and organizations a secure way to exchange digital money since they’re guaranteed by the government and regulated by a central bank. However, traditional currencies lose value over time through inflation.

Should users be concerned about CBDCs?

Many users worry that once CBDCs are implemented, the government will be able to more easily control their financial lives. They can in theory freeze people’s accounts and stop them from spending on items they deem unacceptable. To many, this is a scary, dystopian nightmare. 

From a safety perspective, before a country implements a CBDC, it must carefully analyze its challenges. When buying CBDCs, customers can withdraw an excessive amount of funds from banks all at once, sparking a run on the banks that would restrict their capacity to lend and increase interest rates. That’s a particularly pertinent issue for countries with unstable financial systems.

CBDCs are also susceptible to cyberattacks. Any currency issued by central banks is always liable to such threats, so the relevant authorities need to thwart any system infiltration and protect assets from hacking.

Central banks and governments will also have to implement robust structures to protect consumers and maintain their privacy––one of the primary motivations for cryptocurrencies is privacy. To watch CBDCs for embezzlement, regulators must interfere with them appropriately. Monitoring is crucial since it helps in the fight against money laundering and theft.

The U.S. financial system may undergo significant transformation by implementing CBDCs. Their effects on consumer spending, investments, bank reserves, interest rates, and the overall economy are unknown.

CBDC vs. crypto

CBDCs are centralized, meaning a particular country's government backs them. On the other hand, crypto is a crucial component of DeFi (decentralized finance) as no government, central bank, or intermediary interferes or watches over the activities on a cryptocurrency’s blockchain. Blockchains are distributed ledgers that contain all records of a given cryptocurrency’s transaction history. With crypto, any changes to a blockchain must be approved by all nodes on the network.

Cryptocurrencies require blockchains to exist and operate. Depending on the country and their methods, CBDCs may or may not use a blockchain to work. This means CBDCs are privatized and require “permission” from the government, while crypto is a permissionless digital currency.

Crypto users can also remain anonymous while transacting, as individuals don’t need to use their names for identification. Instead, each person has a public key linked to their crypto wallet, which is used to buy and sell cryptocurrencies. CBDCs will be linked to a person’s bank account, which requires their name and other personal information.

CBDCs are managed by a central authority, making network scalability simpler. The central bank, which handles operational tasks and maintenance, determines its value. Cryptocurrencies like Bitcoin can skyrocket in value and fall quickly, thanks to their volatility.

CBDCs vs. stablecoins

Stablecoins are a form of cryptocurrency, which means they are decentralized. They’re unregulated digital assets, whereas CBDCs are overseen by a country’s primary financial institution, making them centralized.

However, stablecoins are similar to CBDCs as their value is also pegged to another asset. This can be a fiat currency, other cryptocurrencies, or exchange-traded commodities like real estate, oil, and gold. For example, USD Coin (USDC) aims to maintain a 1:1 ratio with the U.S. dollar.

As a result, stablecoins may use private money as a reference asset, but CBDCs are backed by the reserve assets of their native countries’ central bank money. Some stablecoins like Tether have come under scrutiny regarding their reserves and the amount of transparency shown to the general public.

With such a similarity, can CBDCs and stablecoins coexist, especially when stablecoins aim to establish a more democratic financial system? At the same time, CBDCs remain under the control of a country’s central bank in a traditional oligopoly, so how would this work?

This is still a gray area, as CBDCs are yet to be implemented in many countries. However, once this happens, it’s likely that both assets will be able to coexist as stablecoins are cryptocurrencies, making their integration faster and more seamless—especially with cross-border payments.

Which countries are currently using CBDCs?

CBDCs are a proof-of-concept in many countries. Smaller countries are at the top of the pile when carrying out CBDC pilots, while larger countries have spearheaded research and pilot programs in recent years, including those in China, Sweden, Canada, and the U.K. China's pilot is expected to take off in 2023.

As of May 2020, only 35 countries were exploring CBDC implementation, according to the Atlantic Council. Currently, 105 countries are pursuing ways to implement CBDCs into their economies, while 50 are either in the development, pilot, or launch phase.

Globally, 10 countries have launched their own CBDCs. Jamaica is one of the more recent examples, having introduced its CBDC, the JAM-DEX, in July 2022. The Bahamas launched its own CBDC, the Sand Dollar, in late 2020. The Sand Dollar has made it easier to conduct financial transactions across a wide island group. Additionally, its objective is to lower service delivery charges, increase financial inclusion, and enhance customers' ease of use.

Among the G7 countries, the U.S. and the U.K. are still playing chase in terms of CBDC development. However, the European Central Bank intends to introduce its own digital currency by 2025, with a focus on Web3 integration.

Of the G20 economies, 19 are considering CBDCs, with 16 of those in the development or pilot stages. Among these are Russia, India, South Korea, and Japan.

Nigeria—Africa’s largest economy—launched its own digital currency, e-Naira, in October 2021. Ghana and South Africa are in the pilot stages, with multiple other African countries conducting research.

Wrapping up

CBDCs are a new form of money that can coexist with current financial systems, stablecoins, and other emerging cryptocurrencies. More countries are starting to adopt digital currency, yet a mere 3% of the world’s population has been exposed to crypto technology.

At Worldcoin, we aim to change by giving away a free share of our cryptocurrency to every individual on the planet. Our goal is to grow an inclusive global digital economy that supports users’ privacy and anonymity. To start our initiative, we’re airdropping free DAI to anyone who downloads the Worldcoin app. Subscribe to our blog to stay up to date on the latest happenings in the crypto ecosystem.

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