What are CBDCs (Central Bank Digital Currencies)?

CBDC is the word on everyone’s lips. But what are CBDCs & why are governments looking at issuing CBDCs? Find out. 🏦💰\

What does CBDC mean?

CBDC stands for Central Bank Digital Currency. A CBDC is a digital currency issued by a central bank, rather than a commercial one.

But knowing what CBDC stands for doesn’t actually help in deciphering what a CBDC is and what CBDCs can be used for, so let’s break down the jargon.

Central vs. Commercial Banks

Understanding the difference between a central bank and a commercial bank is key to understanding CBDCs.

A central bank is a public financial institution. It manages a given country's (or countries’) currency by creating and managing monetary policy. For example, the Federal Reserve is the central bank of the USA.

Meanwhile, commercial banks provide financial services to the public, including individuals and businesses. For example, JPMorgan Chase is a large commercial bank in the USA.

With that terminology out of the way, let’s take a look at what CBDCs are.

What are CBDCs?

CBDCs are tokenized versions of existing fiat currencies, potentially built using blockchain technologies. Unlike cryptocurrencies like USDT, CBDCs are issued by a central bank

This means CBDCs are (or will be) regulated by a centralized authority and the liability of a given central bank.

Is a CBDC a cryptocurrency?

No. CBDCs are not cryptocurrencies. While CBDCs share some similarities with cryptocurrencies, they are not the same thing.

Cryptocurrencies may be centralized by being issued by a given company, like USDC, or decentralized, like Bitcoin, by being distributed via a decentralized ledger. Either way, cryptocurrencies are not issued or controlled by a central authority, like a central bank.

While CBDCs may share some technical features. For example, they may utilize some aspects of blockchain technology, CBDCs are issued by a central bank and effectively backed and managed by the government.

The centralized nature of CBDCs comes with both its advantages and disadvantages.

What are the benefits of CBDCs?

There are many potential benefits to CBDCs for both investors and the government. The benefits for investors include:

• While stablecoins are pegged to the value of a given fiat currency, investors need to have certainty in that stablecoin’s reserves or algorithmic stability. CBDCs would be the liability of the central bank and therefore have guaranteed reserves.

• There is a reduced risk of a bank run with a CBDC, and if there is, the risk lies with the central bank.

• CBDCs may allow more efficient and faster payments than traditional payment methods.

• CBDCs may reduce transaction costs associated with traditional payment methods.

• CBDCs may streamline cross-border payments and improve access to other fiat currencies for investment purposes.

• CBDCs may improve the mainstream adoption of new innovations like smart contracts and decentralized finance.

• CBDCs may help improve access to finance for those who struggle to gain access to traditional financial products, also known as the unbanked population, for example, people in remote areas or people without an ID.

The benefits for governments and institutions include:

• CBDCs will be cheaper to issue than physical cash and likely more popular in a post-COVID era.

• CBDCs provide increased transparency for governments and may help authorities more easily monitor and tackle illicit activities like money laundering.

• CBDCs may help central banks capture a market share and compete with the rise in popularity of private digital tokens, most of which operate outside financial regulations.

• CBDCs may help central banks preserve and improve the position of their fiat currency in the global economy. For example, the US Dollar is the most widely used currency worldwide, and a USD CBDC may help preserve and support this.

• CBDCs may establish a direct connection between consumers and central banks, eliminating the need for financial intermediaries like commercial banks.

• In theory, governments could create CBDC subsidiaries to support low-income households and provide better financial support and services. Whether governments would actually do this is another matter entirely.

As you might have noticed, many of the benefits of CBDCs for institutions are inherent risks for investors.

What are the risks of CBDCs?

CBDCs have many potential risks too, for both investors and institutions:

• CBDCs are a privacy concern for investors. Governments and central banks will be able to monitor and track your financial transactions far more easily.

• Some think tanks have raised not only the issue of surveillance of CBDCs and the lack of privacy but also warned that CBDCs could lead to intrusive changes to the taxation system.

• CBDCs may be vulnerable to cyber attacks if not implemented properly and maintained with best-in-class security practices. A successful cyberattack may bring financial instability to entire populations.

• CBDCs may eliminate the need for financial intermediaries. This is both a pro and a con, as it may have significant impacts on the economy.

• CBDCs may have significant impacts on monetary policy, both good and bad.

• CBDCs may face many adoption and implementation challenges, particularly for older generations.

• While CBDCs may give improved access to the unbanked population, there is an equal risk that they may exclude those who do not have access to the technology or infrastructure to access CBDCs, as well as those unable to provide adequate KYC identification.

• CBDCs have both technical and operational risks if the underlying infrastructure isn’t developed properly.

What’s the purpose of CBDCs?

Much of the hype around CBDCs you see in the news today comes as a direct result of the impact cryptocurrencies have had on the global financial market, both good and bad.

Cryptocurrencies have improved financial inclusivity worldwide, as well as innovating new borderless financial opportunities, thanks to the DeFi market and stablecoins in particular.

But they're not without their risks, even for stablecoins. Most investors remember all too well the fallout when the TerraUSD algorithmic stablecoin de-pegged permanently, leaving billions in losses, despite promising investors that their assets were pegged to a particular value.

The rise (and sometimes fall) of crypto, as well as COVID speeding up our growth towards effectively cashless societies, has shifted government focus towards CBDCs, both to potentially offer regulated digital currencies for investors and to continue moving towards a cashless world.

Use cases for CBDCs are plentiful. Take the example of exchanging currencies to travel. Although some apps exist to aid cashless currency exchange and travel, with CBDCs, this process could potentially be much cheaper and with better exchange rates, allowing for easy, cashless currency exchange.

This, though, is an example of a retail CBDC, and there are actually two kinds, with two distinct purposes.

Retail vs. wholesale CBDCs

We mentioned a retail CBDC above. This is a CBDC primarily used by individuals for retail payments, like cash or like many investors currently use stablecoins. Unlike stablecoins, retail CBDCs are backed by a central bank.

Wholesale CBDCs would be utilized by financial institutions, commercial banks, and central banks. Wholesale CBDCs could potentially solve a wealth of problems within traditional financial systems, for example, by improving payment speed and streamlining cross-border transactions.

While there are two distinct kinds of CBDCs that central banks are looking at implementing now, there’s no reason with the right infrastructure and development that a CBDC couldn’t serve as both a retail and wholesale CBDC.

Which countries have CBDCs?

According to research from the Atlantic Council, there are 11 CBDCs launched:

• Nigeria

• Jamaica

• The Bahamas

• Anguilla

• Saint Kitts and Nevis

• Antigua and Barbuda

• Montserrat

• Dominica

• Saint Lucia

• Saint Vincent and the Grenadines

• Grenada

As well as this, 18 countries now have CBDCs in pilot stages, including:

• Russia

• Sweden

• Ukraine

• Kazakhstan

• Iran

• Saudi Arabia

• United Arab Emirates

• Ghana

• South Africa

• China

• India

• South Korea

• Japan

• Hong Kong

• Thailand

• Singapore

• Malaysia

• Australia

These are by no means the only countries launching developing CBDCs, though. Overall, there are 119 countries with a CBDC either launched, being trialed, in some form of development, or researching a CBDC.

Which countries are developing CBDCs?

Let’s take a quick look at some of the biggest financial players and where they sit in the race to launch a CBDC.

United States CDBC

Trump signed an executive order that prevented federal agencies from endorsing or issuing CBDCs, so it's unlikely the US will be seeing any progress in CBDCs while this administration is in power, despite previous interest from the Biden administration.

United Kingdom CDBC

The Bank of England and HMRC released a consultation paper a couple of years ago outlining the case for a 'Britcoin'. As well as this, the government has been advertising CBDC-related roles, and the Bank of England has announced it is soliciting vendors for a CBDC wallet, suggesting a launch of a digital pound may be imminent.

Australia CBDC

Australia's CBDC is in the pilot stages now. The Reserve Bank of Australia, alongside the Digital Finance Research Cooperative Research Centre, has outlined the technical requirements for Australia's CBDC, eAUD, and invited public comments. eAUD is currently planned to be utilized as both a wholesale and retail CBDC. More recently, Australia’s central bank is launching “Project Acacia,” a pilot program testing 19 real-asset use cases and 5 proofs-of-concept to explore how a wholesale CBDC and related digital assets might work in financial markets.

Canada CBDC

The Bank of Canada has been conducting research and development work into CBDCs since 2017, including how it might work, what features it should have, and its potential effects — as a backup option if needed in the future. After extensive study and public consultation, they’ve recently scaled back work on a retail CBDC and are redirecting efforts toward improving Canada’s payments infrastructure and policy for evolving digital payments.