How will Central Bank Digital Currency (CBDC) change your future
What is CBDC
Recently, central bank digital currencies (CBDCs) have become a popular subject in the financial world. The introduction of a new type of digital currency and its effects on monetary and fiscal policy are the subject of research and analysis by banks, institutions, and governments. Let’s start by understanding what actually Central Bank Digital Currency is.
Central bank digital currencies are digital tokens, similar to cryptocurrency, issued by a central bank. They are pegged to the value of that country’s fiat currency. CBDC’s can be compared with stable coins, these are cryptocurrencies that are fixed to the value of the fiat money and try to keep the value constant. The differentiating factor for the two is that CBDC’s are issued by the government of an entire nation.
Even though the physical currency is in great use today, but after the COVID-19 era the countries saw a rapid shift to digital payments and transactions across all verticals, be it paying bills or buying groceries. This has led to countries moving even faster towards this new technology of CBDC. Various developed nations have already made good progress in adopting this technology whereas developing nations are still working towards it. India recently launched its pilot project for e-Rupi on 1st November 2022.
How does CBDC Work
Each CBDC functions similarly to a nation’s current fiat currency because it is a digital replica of that currency. There may be variations in how CBDC of each country operates because each country is developing their own CBDCs, but they all adhere to the same fundamental paradigm. CBDC’s are issued by the Central Bank of a country, which is backed by a central government. This enforces the CBDC to be used as a legal tender while paying someone or purchasing goods and services.
This might raise a question in your mind, aren’t online transactions the same. Well, the main difference between both is that a normal online transaction takes place via multiple banks, but a CBDC transaction will be executed only by the Central Bank. This helps in reducing the transaction days from 3–5 days to almost instantly. Therefore, users who don’t have any bank account can also use the CBDC to make transactions in their day-to-day activities.
Applications of CBDC
Central Bank Digital Currency is a very useful technology for people all over the world. There are 2 types of CBDC, wholesale CBDC, this is used by the banks, and Retail CBDC which is used in daily lives by consumers like you and me. Below listed are some of the applications of CBDC:
- Conditional Transactions — As CBDC is implemented using a smart contract it can be used for various conditional transactions, such as subsidies. It can be programmed to provide subsidies to people of lower income according to the slabs and update the subsidy amount when the income criteria changes. This can be useful in various subsidies like food subsidies, education subsidies, etc.
- Credit Score — The transaction data of CBDC is stored on a single ledger and is completely transparent, this can act as a very good source to measure the credit score for an individual and provide loans.
- No Geographic Limitations — Physical currency is not easily accessible in every part of a country, sometimes it may take a day or half to just go to the bank and get cash. In such cases CBDC improves the process by digitally transferring cash from one person to another.
- Organization Independent — As mentioned before CBDC is independent of any private or state bank, it is monitored directly by the central bank. This allows citizens even without bank account to make transactions simply using a smartphone and a valid identity card. Even in remote areas like villages, people having less or no connectivity at all can also make transactions using the CBDC technology.
- Cross-Border Transfers — Another major revolution that CBDC brings is in the field of cross-border transfers. Currently cross-border transfers are very expensive and are controlled by certain exchanges such as Western Union, etc. With CBDC technology one can transfer directly from account in one central bank to the account in another central bank. Currently this is not functional as no country has found the right technology to do it.
Till now there are a few countries who have launched their own CBDC’s. Like the Sand Dollar issued by the Central Bank of the Bahamas, China is testing its digital yuan, and Nigeria is launching eNaira, being the first African Nation to launch a CBDC. India has also launched its E-Rupi pilot project on 1st November 2022 which saw a trade of Rs. 275 Crore on its first day itself.
You may mix CBDC’s with cryptocurrencies, as they have the same general concept, but they do differ a lot in implementation. Centralization is the main distinction between CBDCs and cryptocurrencies. A cryptocurrency is a decentralised digital money, which means that it is not governed by a single entity. For CBDCs, the transactions are stored on a public ledger and controlled by a centralized authority i.e., Central Bank.
CBDCs are still in their infancy, but it’s evident that the concept is gaining traction. More than 90% of the global gross domestic product (GDP) is accounted for by the nations that are investigating them. Even while CBDCs might not completely replace cash, most nations will probably at least use their own digital currencies in some capacity.
Do let us know if this was useful information for you. Please feel free to share your suggestions and opinions in the comments section below.
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