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EducationalApril 30, 2021

What are Central Bank Digital Currencies (CBDC)?

Shubham Goyal
Product Specialist
April 30, 2021

If you have been familiar with the world of cryptocurrencies for a while now, you probably have heard the term ‘CBDC’ being thrown around. CBDC stands for Central Bank Digital Currency, often likened to a national cryptocurrency as well. In this post, we have rounded up everything you might want to know about these CBDCs!

First of All, What Exactly is a CBDC?

A central bank digital currency is a digital representation of a country’s government backed, central bank controlled national currency. As you might have gathered by now, this is why a CBDC is called a national cryptocurrency. Aside from that, CBDCs are also known as digital fiat currencies and digital base money. As of 2021, CBDCs are very much a completely new type of currency that walks a fine line between cryptocurrencies and fiat currencies, and they are mostly untested so far as only a few countries have tried them out.

In fact, China is the only country to have tested out the possibilities of a digital yuan; however, the USA and even India are not very far behind.

As per historical data, Facebook’s cryptocurrency Libra comes out as the factor to have prompted central banks around the world to start considering the usability and effectiveness of national cryptocurrencies. While the decentralized and permissionless structure of cryptocurrencies have been appealing to traders since Bitcoin’s launch in 2009, and by this point, they have grown popular enough to replace traditional financial systems controlled by an authority figure, various governments from around the globe never really cared much about the threat cryptos posed to fiat monetary systems.

However, in 2019, Facebook’s launch of their very own cryptocurrency – Libra, made central banks first realize that a crypto launched by a company as powerful as Facebook could very easily draw a major portion of the general populace away from centralized finance. This was the time when governments from a handful of countries first began trying to manage the growing popularity of cryptocurrencies and simultaneously started to explore whether they could integrate similar technology into the existing centralized financial systems or not.

The design of a central bank digital currency is supposed to be different for every country, based on factors such as privacy, access, and the underlying architecture of the systems. However, most central banks have chosen to use the blockchain tech powering most cryptocurrencies in today’s time as the backbone for their national cryptocurrencies. Blockchain is expected to simultaneously increase trading efficiency significantly and facilitate cost-effective transactions with CBDCs.

How Does a Central Bank Digital Currency Work?

A central bank digital currency is meant to bring together the best of two worlds – while they have to be accessible and secure as digital currencies, they will also have to facilitate the regulated, reserve-backed, and non-volatile money circulation of traditional finance. Since a CBDC is centralized, all operations of a national cryptocurrency are to be sanctioned and monitored by the central bank and government of a particular country.

Each CBDC unit will act as a secure digital instrument, exactly the same as a paper based currency token. And similar to paper bills carrying unique identification numbers, each CBDC unit will also have a unique identifier attached to them so they can be traced easily, and any threats of counterfeit money can be avoided.

As mentioned earlier, different central banks have considered varied underlying architectures for CBDCs, and most have decided upon the blockchain and distributed ledger technology (DLT). However, the distributed part of DLT directly clashes with the fact that a national cryptocurrency is supposed to be centralized. So governments that have chosen this technology for their CBDCs also have to try and do away with the security and scalability issues that come with blockchain and the DLT.

Categories of CBDC:

Central bank digital currencies are still too new to assess how many different types of coins there are going to exist. CBDCs in different countries might vary based upon accessibility, usabilites, and other factors. However, at this point, it’s safe to assume that we’ll see at least two types of national cryptocurrency, namely:

  1. Wholesale CBDC: This kind of CBDC will only be exchanged between central banks and private banks. The exchanges will help make the transactions between these organizations more efficient, allow for smoother cross-border transactions, and decrease counterparty credit and liquidity risks.
  2. Retail CBDC: Retail CBDC is a truly national cryptocurrency for the use of the general populace. People will be able to use it to pay for their day to day necessities.

Central Bank Digital Currency in India

A national cryptocurrency in India is very close to becoming a reality in near future. This is because to stay on the same page as countries like China and the USA that are already planning for a CBDC, on 25 January 2021, the Reserve Bank of India (RBI) has announced that it is investigating the possibilities for a central bank digital currency in India.

The Lok Sabha Bulletin Part II states that The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 is supposed to be introduced by the Government of India during the Budget session of the Parliament, and it could possibly involve the banning of the trades of private cryptocurrencies like Bitcoin or Ethereum in India. While that is not a very great news for the crypto trading community in India, at least it will also provide the Reserve Bank of India with the legal authority to develop a CBDC.

With an Indian national cryptocurrency, the RBI will be able to take a huge step closer to achieving total financial inclusion in India, and the digital rupee would also bring about a cashless society, and empower the citizens and the government alike by expanding the digital economy.

And that was all the details regarding CBDCs you might want to know! If you’d like to find out more about new DeFi projects to invest in, crypto options trading, and the world of cryptocurrencies in general, don’t forget to give our blog a visit!

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