Central Bank Digital Currency Explained.

“Central Bank Digital Currency,” a new sort of currency being tested by governments all around the world

By Anna B Kiwanuka

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CBDC stands for “Central Bank Digital Currency,” a new sort of currency being tested by governments all around the world. What distinguishes a CBDC from other currencies is that proponents believe it will be able to employ new payment technologies, such as a blockchain, to improve payment efficiency and reduce costs. These are electronic versions of a country’s fiat currency.

The International Monetary Fund (IMF) considers CBDCs to be a new form of money that are:

🤖 In a digital form

🏦 Issued by a country’s central bank

💵 Intended to serve as legal tender

CBDCs comparable to stablecoins, which are tethered to a fiat currency at a 1:1 ratio. However, private businesses manage stablecoins like Tether (USDT), which are backed by central bank-issued cash or cash equivalents. They keep these assets in order for their stablecoins to accurately reflect the value of fiat currencies.

The creation of this new sort of currency is still in its early stages. Most countries, such as the United States, are just getting started with the concept of a digital currency. A few forward-thinking countries, like China with its digital yuan and South Korea, have already completed a demonstration and are putting the technology to the test. However, a CBDC has yet to be used in a large-scale deployment. In Africa, Nigeria, Ghana, South Africa, and Kenya are leading the change.

Each country that is considering establishing a CBDC has its unique strategy. Several CBDCs are built on the same basic ideas and blockchain technology that underpin Bitcoin, the first cryptocurrency.

Blockchain technology allows multiple entities to keep a copy of a transaction history, allowing the history to be distributed rather than controlled by a single party.

Several countries have been reported to be experimenting with CBDCs based on the blockchain. Venezuela was a forerunner in this regard, establishing the petro, its own cryptocurrency, in 2018. However, the petro is beset with issues, and only a small percentage of Venezuelans utilize it.

Aside from Venezuela, China’s government is likely the most advanced in its efforts to establish a CBDC. It is already experimenting with a digital yuan in a number of cities. The Federal Reserve Bank of Boston is also experimenting with a digital dollar in collaboration with the prominent Massachusetts Institute of Technology (MIT).

How do CBDCs work?

Blockchain is sometimes mentioned as the underlying technology for CBDCs by states developing central bank digital currencies, but the central bank retains control over the ledgers. Cryptocurrencies, on the other hand, are decentralized and do not have a central authority.

CBDCs can be used in a variety of ways by state governments. CBDCs, on the other hand, tend to work on mobile wallets akin to Apple Pay or Google Wallet, based on early prototypes.

The central bank of the Bahamas, which fully implemented a CBDC in October 2020, issues Sand Dollars in the same way that it issues Bahamian dollars. It also keeps track of all the Sand Dollars in circulation.

The Future of CBDCs

More countries will launch fully-fledged CBDCs over the mid-term, with China leading the charge. China will roll out the digital yuan during the Beijing 2022 Winter Olympics in February. However, some U.S. Senators have urged a ban on American athletes “receiving or using digital yuan” during the tournament, fearing that it could be used to surveil those visiting China “on an unprecedented scale”.

Concerns about privacy are only going to get louder. Some CBDC proponents have argued that digital currencies are more private than privately issued stablecoins because “we have no commercial interest in storing, managing, or monetizing the data of users.” In June 2020, ECB executive board member Fabio Panetta argued that a digital euro would be more private than privately issued stablecoins because “we have no commercial interest in storing, managing, or monetizing the data of users.”

Others, on the other hand, have expressed worries about the privacy implications of CBDCs, because they allow states to keep a close eye on monetary flows on a macro level—and, more problematically, on an individual level. The digital yuan will have “limited anonymity,” according to Mu Changchun, director of the People’s Bank of China’s Digital Currency Research Institute, with minor payments connected to users’ phone numbers and larger transfers requiring more thorough KYC data.

Conservative senators in the United States have argued that China’s digital yuan may be used to “extend domestic surveillance activities” or even “impose party discipline” in the country. A CBDC, according to Congressman Tom Emmer (R-MN), would only be advantageous if it was “open, permissionless, and private.”

While many central banks see blockchains as bringing benefits such as efficiency gains, several central banks have expressed skepticism, arguing a blockchain-inspired CBDC does not bring enough benefits to justify creating and maintaining one.

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