Cryptocurrencies have grown in popularity significantly, reducing the chances of fiat money becoming successful in the future. The increasing popularity is because cryptocurrencies – which are built on decentralized ledger technology – are far more efficient for payment, transactions and other use cases.
As a result, central banks have seen the need to create an alternative currency with the same efficiency as decentralized cryptocurrencies like Bitcoin, but with them in control. This brought about the idea of a centralized digital currency (CBDC).
What are CBDCs?
A CBDC is a digital currency issued by a central bank. They are not necessarily issued on a blockchain, but are faster and cheaper for transactions than the conventional fiat money. CBDCs are created as an alternative to decentralized cryptocurrencies like Bitcoin which have no central control.
While anyone can verify transactions on Bitcoin’s network, this isn’t the case with a CBDC, as only authorized persons can access the transaction information on the network.
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There are several arguments for and against CBDCs. For example, governments pushing for them say the goal is to bring financial inclusion by banking the unbanked. They say it is meant to fight crime, since it is 100% transparent and nothing happens on the network without the central bank knowing.
On the other hand, critics of CBDCs argue that they are instruments of control. For example, with transactions being fully traceable by the central bank, they can tell what you’re doing with your money without seeking your consent.
Also because the money is programmable, it can be modified to define use cases for the currency that if violated, could make the money useless. For example, the central bank can decide that you can’t buy certain things with your money.
They may also freeze your funds if they don’t like how you spend it. While this can indeed be good for fighting crime, it can also be used for intrusive surveillance that violates people’s privacy.
Types of CBDCs
CBDCs can be of two types – Retail and wholesale. The names are based on how they are used.
A retail CBDC is one that is distributed to the public. As the name implies, its is used for retail purposes – buying, selling, payments – just like normal fiat currency, only in a digital form. This type of CBDC is anonymous, traceable, available 24/7, and can have interest rates applied.
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There are two types of retail CBDCs. The first is a token-based retail CBDC, and the second is an account-based retail CBDC.
Token-based retail CBDCs are accessed with private keys, public keys, or both, similar to decentralized digital currencies. Such CBDCs can be used for anonymous transactions. Account-based retail CBDCs on the other hand require digital identification to access.
Transactions with account-based CBDCs are never anonymous, since the use of digital identity is involved.
These CBDCs are used by banks that keep reserve deposits with a central bank. Wholesale CBDCs can be used to increase payments and securities settlement efficiency. These CBDCs can also be used to replace or supplement central bank reserves.
Pros and Cons of CBDCs
CBDCs come with a lot of baggage, including advantages and disadvantages. The following are some of the pros and cons of CBDCs you need to know.
CBDCs have the following pros.
1. It makes it easier for governments to implement monetary and government policies.
2. Account-based retail CBDCs can be used to easily trace and fight crimes.
3. Reduces infrastructural costs involved in linking citizens to the central bank’s monetary system.
CBDCs also have their own disadvantages. The following are some of these cons that critics of the idea have highlighted.
1. CBDCs can be used for surveillance purposes that may violate users’ privacy.
2. They may disrupt the existing financial system
3. Users’ data is exposed to risk of misuse, either by the central authority or by unauthorized persons who hack the system.
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