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Central Bank Digital Currencies

What is a Central Bank Digital Currency (CBDC)? How does it vary from fiat money, credit, or debit cards?

The digital currency of a banking system is backed by the central bank of the corresponding government, which means they take the responsibility, not commercial banks or private companies.

Fiat money bank notes
Fiat money bank notes (by @ninjason)

The world's largest central banks are beginning to realize that they have to get into the play and let the future of cash pass them by as decentralized virtual currencies such as bitcoin have become more common. China launched a pilot project for its virtual yuan in four cities last month.

Benefits of using CBDCs

A Bank for International Settlements (BIS) report aims to examine the establishment of CBDCs as a payment system. It would indeed be available 24 hours a day, 365 days a year and payment would've been sent instantly, unlike many other current bank transfers. Never again struggling for a move for three business days.

Similar to existing contactless payment methods in supermarkets, CBDCs may also be used, but it is likely to be in money transfers where the greatest advantage will occur, bringing a degree of confidentiality to payments. Say, for instance, that someone owes you $50, but they do have no cash. The debtor needs the bank details for you to collect the money currently owing, however, it may be possible to tap a prepaid debit card, your mobile, or scan a QR code with CBDCs, without giving over any confidential info.

With a centralized structure in place, it will also be possible to simplify the time-consuming process of navigating notoriously costly foreign payments. Trying to make the others as straightforward as possible for the general populace to use is most vital to the success of CBDCs. CBDC payments should ultimately be like using money, trying to tap a card, or swiping a cell phone to encourage acceptance and availability. It must also be incredibly cheap or free to use.

Risks of CBDCs

In such a digital era, central banks have begun investigating the advantages and drawbacks of providing digital currency as a manner to "develop" and continue pursuing public policy goals with a "specific application." A serious feeling is that the implementation of a CBDC will cause possible bank runs to catalyze and thus weaken the funding position of banks.

Even so, the Bank of England showed that the prevalence of a system-wide run from savings accounts to CBDC is addressed if the introduction of the CBDC follows a set of core principles. The release of a Central Bank digital currency requires careful planning: people could pull quite enough money out of banks at once and buy CBDCs, causing a run on banks; centralizing a system that is designed to be private through all the government can generate a backlash among customers and make cybersecurity risks; our regulatory procedures are not modified to adapt with the current forms.

Since many central banks are using forms of digital money as deposits or balances of settlement accounts, no specific CBDC has yet been released by any banking system. Even so, some banks, such as the world's five main currencies, the U.S. dollar, the euro, the Japanese yen, the British pound, and the Chinese yuan, are now at different stages of the research process and growth.

A white paper detailing the priorities of the "digital dollar" was released by a U.S. think tank in May. Events have also been making substantial progress since then. Japan's latest news would be that the banking sector has selected its leading economists to lead this team investigating a yen-based CBDC, whereas the Bank of England has appointed Accenture to establish its own CBDC.

The European Central Bank (ECB), meanwhile, seems to be leaning towards a retail CBDC, and this tends to make it the largest project at the moment, given the fact that it would operate across 19 countries.

Bottom Line

The adoption of CBDCs by the biggest economies in the world seems inevitable. CBDCs will transform the way governments, companies, and people manage money. CBDCs may look like cryptocurrencies, but there are important differences: A CDBC is, by definition, a centralized payment method. The COVID-19 crisis is accelerating the efforts of Central Banks to define digital versions of their currencies.

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