What are CBDCs?
Central bank digital currencies (CBDCs) are electronic counterparts of government-backed money issued by central banks, tied to a nation’s currency. Unlike cryptocurrencies, such as stable coins, which aim to maintain a stable value but aren’t government-backed, CBDCs are issued by governments globally. Understanding CBDCs is essential for cryptocurrency investors, as more than 80 countries are actively exploring and developing CBDCs, each at different stages, with some already launched.
How CBDCs Operate
CBDCs work similarly to traditional fiat currencies, authorized by a central bank as legal tender for various transactions, such as payments and purchases. Unlike conventional bank transfers that traverse multiple banks and may take days, CBDC transactions occur almost instantaneously on a single digital ledger. Importantly, individuals without a bank account can transact using CBDCs.
Types of CBDCs
CBDCs can be retail or wholesale. Retail CBDCs are for the general public and function as digital wallets for everyday payments. They offer a safe alternative to cash, especially for the unbanked. Several countries, like the Bahamas, have already adopted retail CBDCs. Wholesale CBDCs, on the other hand, are used by financial institutions for faster fund transfers and enhanced security in domestic and cross-border transactions.
CBDC as a Medium of Exchange
CBDCs can serve as an efficient medium of exchange if they offer competitive interest rates. Unlike traditional bank deposits, which provide minimal interest, a CBDC with a compelling interest rate could discourage users from shifting funds to less liquid risk-free assets.
CBDCs vs. Cryptocurrency
CBDCs differ from cryptocurrencies in that they are centralized and government-regulated, while cryptocurrencies operate independently of central authorities and offer higher privacy levels. CBDCs, with their centralized nature, enable central banks to monitor and track transactions, raising privacy concerns.
Drawbacks of CBDCs
CBDCs centralize money further, giving central banks significant control and potentially eroding privacy. They may take time to gain acceptance, and some may be…