Central Bank Digital Currencies (CBDCs): What Exactly Are They?

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CBDCs promise to combine peer-to-peer electronic money transactions with fiat currency economic clout. Here is a list of the countries that are working on them.

CBDCs, or central bank digital currencies, are exactly what their name implies: digital representations of a state’s fiat currency. But how does that vary from money existing in a digital bank account and being used to conduct cashless debit card transactions?

Why do governments desire CBDCs in the first place? And which countries have CBDC initiatives in the works?

What is a CBDC?

CBDCs are digital versions of a state’s fiat currency.

They are comparable to stablecoins, which are tied to a specific fiat currency at a 1:1 ratio. Stablecoins, on the other hand, such as Tether (USDT), are managed by private organisations that hold central bank-issued cash or cash equivalents. They hold those assets in order for their stablecoins to accurately reflect the value of fiat currencies.

CBDCs are regarded by the International Monetary Fund (IMF) as a new type of money because they are:

  • ? In a digital form
  • ? Issued by a country’s central bank
  • ? Intended to serve as legal tender

Central banks literally print US dollars or British pounds, so the physical banknotes in your wallet don’t meet the criterion of “digital form.”

And the money you move digitally through your bank is in fact a series of electronic deposits backed by the assets of commercial banks—97% of the money held by regular people and businesses in the UK are actually commercial bank deposits.

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Bitcoin, the world’s most popular cryptocurrency, fits two of the aforementioned criteria: it is digital and is now legal tender in El Salvador. However, the “CB” in CBDC has nothing to do with Bitcoin. It is not issued by the Central Reserve Bank of El Salvador—even if the bank mined Bitcoin on a large scale, that would not be considered “money issuance,” according to a former IRS attorney in June 2021.

How does a CBDC work?

While states adopting central bank digital currencies may claim blockchain as the underpinning technology for CBDCs, the central bank ultimately retains control over the ledgers. Cryptocurrencies, on the other hand, are decentralised, with no central authority.

CBDCs can be used in a variety of practical ways by states. However, based on early studies, CBDCs appear to be based on mobile wallets akin to Apple Pay or Google Wallet.

In the Bahamas, which will fully implement a CBDC in October 2020, the central bank issues Sand Dollars in addition to Bahamian dollars. It also keeps track of all Sand Dollars in circulation.

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In partnership with private providers, the central bank maintains a KYC infrastructure that citizens need to comply with to open a mobile wallet. Sand Dollars facilitate peer-to-peer electronic payments without an intermediary like a bank account, which is the main idea behind CBDC projects: scan the barcode on your phone to make an in-store payment or send money to another mobile wallet.

Why do governments want a CBDC?

In its annual report (June 2021), the Bank for International Settlements highlights three causes for the recent rise of CBDCs: the interest in Bitcoin and other cryptocurrencies, the discussion over stablecoins, and the entry of Big Tech into finance.

Concerns about huge digital businesses infiltrating finance, such as the Facebook-backed stablecoin Diem, are shared by the European Central Bank (ECB). The European Central Bank (ECB) stated in a June 2021 paper that governments who do not implement CBDCs may face threats to their financial systems and monetary autonomy from “foreign tech titans potentially issuing fake currencies in the future.”

But there are many other reasons.

CBDCs could also help speed up money disbursals in times of crisis, as March 2019 research by the Institute and Faculty of Actuaries showed.

The IMF stated in a July 2021 report that CBDCs can boost financial inclusion because citizens do not need a bank account to pay with CBDCs. That is significant in countries such as Indonesia, where one-third of the population lacks access to traditional finance but is more likely to have mobile Internet.

In April 2020, Fan Yifei, deputy governor of the Chinese central bank, stated that a CBDC will minimise illicit money use because physical money is anonymous and more readily counterfeited.

According to MasterCard, which has a stake in electronic payments, the expense of managing physical currency can amount to up to 1.5 percent of a country’s GDP. Countries can save a lot of money by travelling more

—if not necessarily completely—digital.

What countries are working on CBDCs?

As of August 2021, 81 countries, including monetary authorities such as the European Union, were working on a CBDC initiative in some capacity. They account for 90 percent of global GDP.

To present, only five of them have launched CBDCs. The Bahamas, Saint Kitts and Nevis, Antigua and Barbuda, Saint Lucia, and Grenada are all Caribbean island nations.

The vast majority of them—32 countries—are still in the “research” stage. That is when central banks try to find out what the hubbub is all about and whether they really want a CBDC. This includes the United States, which has kept a low profile on its digital dollar explorations. Governments are also taking their time in order to study the security implications of CBDCs.

There are 16 countries in the “development” stage, which is when things get more serious as countries develop proof-of-concepts and launch studies.

The Bank of Japan initiated the first phase of a feasibility study for its digital yen in April 2021, which will last a year before further research is conducted. Meanwhile, South Korea is moving ahead, with its CBDC set to enter the pilot stage in August 2021.

14 countries are presently in the pilot stage, having designed and tested a CBDC in the real world.

The digital yuan, issued by China’s CBDC, is the most popular pilot at the time. By the end of June 2021, it would have been utilised in over 70.75 million transactions totalling 34.5 billion yuan ($5 billion). As part of an effort to test the technology, the country has airdropped millions of digital yuan to citizens—and create some buzz around it.

Sweden’s e-krona is similarly in the pilot stage as of April 2021, although with significantly less hoopla. Cambodia has been testing CBDC since July 2020, and anyone with a Cambodian phone number is welcome to participate, according to the vendor that developed the CBDC blockchain platform.

Ukraine’s e-hryvnia is another experimental CBDC, with real-world CBDC tests set to begin in August 2021. The country’s central bank struck a partnership with Stellar Development Foundation, the group behind the cryptocurrency Stellar (XLM), in January 2021, but it has not stated if its CBDC will be on Stellar’s blockchain.

The future of CBDCs

Over the medium term, more countries will launch fully-fledged CBDCs, with China leading the way.

The digital yuan will be introduced in China at the Beijing 2022 Winter Olympics in February. Some US Senators, meanwhile, have called for a prohibition on American players “receiving or utilising digital yuan” during the competition, claiming that it may be used to spy on Americans visiting China “on an unprecedented scale.”

Those concerns over privacy are only likely to grow louder. Some CBDC advocates have touted the digital currencies as a privacy solution; 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, however, have expressed worries about the privacy implications of CBDCs, as they provide a means for authorities to keep close tabs on monetary movements at both the macro and, more problematically, the individual levels. Mu Changchun, director of the People’s Bank of China’s Digital Currency Research Institute, has previously claimed that the digital yuan will have “limited anonymity,” with minor payments connected to users’ phone numbers and larger transfers requiring more thorough KYC data.

Conservative politicians in the United States have claimed that China’s digital yuan may be used to “extend domestic surveillance measures” or even “impose party discipline.”

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