What are Central Bank Digital Currencies
Central Bank Digital Currencies work on DLT/Blockchain technology to bring certain desirable properties of said technologies to existing central banking systems. Read more to find out what are the implications of this shift.
Central Bank Digital Currencies or CBDCs are distributed ledger/blockchain-based tokens that are used to represent fiat money for a country and can be used as legal tender. The creation of CBDCs is regulated and issued by a country’s central bank, and is therefore highly centralized. Though CBDCs share some of the same properties as traditional cryptocurrencies, there are still many differences one has to be aware of.
The ‘Digital Currency’ part of CBDCs may be somewhat misleading. This is because the vast majority of fiat currencies around the world such as the US dollar, Euro, Yen, etc. already exist digitally. The money that is in circulation in physical forms such as banknotes and coins constitute roughly 10% of the overall money that is being used in the economy. However, the distinction must be pointed out that the current technology that these digital currencies use is databases, instead of DLT/blockchain (albeit a centralized one).
This then brings up another question; if 90% of the world’s fiat money already exists in digital form, then what is the purpose of a CBDC? Why are governments and central banks around the world researching and seriously considering the implementation of this new system?
Many proponents of CBDCs argue that having blockchain-based tokens to represent fiat will mean that it will carry over some desirable properties of blockchain technology such as increased security and convenience for the end-user. Furthermore, the CBDC will most likely be backed by monetary reserves such as bonds, or foreign currency reserves. Lastly, each CBDC unit will be distinguishable by having its own identifying cryptographic hash, which not only prevents imitation but also makes it easier to track money.
Though converting to this system may bring some added upgrades to the existing system, it is not without its flaws. The flaws become even more magnified when you view the implementation of CBDCs from the lens of real blockchain advocates.
As already mentioned, CBDCs are highly centralized. Central banks are always after more control of currency issuance, creation, and by extension the economy. Other than security, the CBDC will not include any other properties that have made traditional cryptocurrencies so popular. This includes:
- Open — Anyone from anywhere can participate in the network, make transactions, and contribute. Central banks running CBDCs will not be allowing this kind of openness.
- Public — Central Banks will want to implement KYC, vet, and control anyone who enters the system. This means that CBDCs will not be anywhere near as open for public use as a traditional blockchain network, such as Bitcoin or Ethereum.
- Borderless — The systems will not be borderless and can only operate in specific borders or jurisdictions. Unlike Bitcoin that exists and can operate everywhere, as long as you connect to one node that is part of the network.
- Neutral — In essence, this means transactions are added to the blockchain regardless of the sender or recipient or the purpose of the transaction.
- Censorship resistant — Some transaction types on CBDCs will not be allowed and blocked by the central bank running it.
- Immutable — The central banks will be able to reverse transactions that have gotten through should they deem it illegal, thus making it not immutable.
As of today, over 40 countries are currently in the process of researching, experimenting, or implementing CBDCs to help improve their current financial infrastructures. Though some benefits for the end-user, the customer, may surface, many blockchain and crypto purists criticize the same innate flaws and inadequacies of a centralized system.