What Is Central Bank Digital Currency (CBDC)?

Cryptocurrencies are usually the first thing that comes to mind when discussing digital currencies, but did you know that even central banks, which regulate monetary policy and distribute currencies, use digital currencies? This is called CBDC and it is becoming more popular with time. So what does CBDC stand for, how does it work, and what is the difference between CBDC and Cryptocurrencies?

TL;DR

• CBDC (Central Bank Digital Currency) is the digital version of fiat currencies like the U.S. dollar or Euro.

• It is issued and regulated by central banks and is aimed at facilitating digital payments and increasing accessibility.

• There are two main types of CBDCs; Retail CBDC (CBDC-R) and Wholesale CBDC (CBDC-W).

• CBDCs are centralised, government-regulated, and tied to fiat currency value, operating on authorised blockchains, while cryptocurrencies are decentralised, more volatile, and operate on public blockchains without government oversight.

• CBDCs could increase market liquidity and improve financial stability but may reduce the need for commercial banks, affecting their stock values.

What Is a CBDC? 

Central Bank Digital Currency, otherwise known as CBDC is, in simple terms, the digital version of fiat currencies like the U.S. dollar and the Euro among other currencies. In addition to being regulated or issued by central banks, CBDCs, are still being developed and slowly adopted by countries around the world in an attempt to transition to digital payments and make payments and monetary transactions easier and more accessible to those who do not have a bank account.

What Are the Different Types of CBDCs

It is important to note that there are two main types of CBDCs; retail CBDC (CBDC-R) and wholesale CBDC (CBDC-W). 

• Retail CBDCs are meant to serve retail and private transactions,

• Wholesale CBDCs are aimed at specific financial institutions like interbank or wholesale transactions

CBDC VS. Cryptocurrency: What's the difference?

CBDCs’ functions are often compared to the way Cryptocurrencies work, but despite this, these two types of digital currencies are different.

First and foremost, unlike Cryptocurrencies, CBDCs’ value is fixed in that they are equivalent to the country’s fiat currency, which is issued by central banks. As such, in times of economic turbulence and inflation, Cryptocurrencies can be more volatile than CBDCs, which tend to hold their value better.

In addition, whereas Cryptocurrencies are decentralised CBDCs are not. This means that whereas cryptocurrency transactions can be done without the involvement or regulation of a third party, CBDCs’ transactions are centralized and regulated by the government. This also means that whereas cryptocurrency transactions can be done anonymously, a CBDC transaction is not. In fact, CBDCs operate on an authorised blockchain while cryptocurrencies operate on a decentralised one.

Where Are CBDCs Currently Used?

While CBDCs are a relatively new and nascent concept, according to the Atlantic Council of United States’ data, as of 2024 over 133 countries are exploring digital currencies, with the combined economy of these countries representing more than 98% of the world's GDP. Moreover, every G20 country is exploring CBDCs, all BRICS member states are piloting them, and countries like the Bahamas, Jamaica, and Nigeria have already fully launched them.

The Future of CBDCs

While the future of  CBDCs is still evolving, experts predict they will become a significant player in global payments by the year 2030. 

According to the projections the value of transactions conducted through CBDCs is expected to surge from $100 million in 2023 to $213 billion annually by 2030. If this actually materialises, it would indicate a substantial growth in adoption and impact. 

Interestingly, several factors are expected to propel this growth, including the desire for enhanced monetary sovereignty, protection against the dominance of card networks, and the increasing popularity of stablecoins (cryptocurrencies pegged to reference assets like fiat money or commodities).

What Are the Benefits of CBDCs?

Some of the benefits of CBDCs include the following:

• Inclusion: CBDCs aim to create financial inclusion and transactions for individuals who do not have a traditional bank account. Additionally, CBDCs can cut back on transaction costs, hence increasing the accessibility and inclusiveness for lower-income households.

• Cost reduction and efficiency: by reducing transaction costs and processing times, CBDCs may improve the efficiency of payment systems, resulting in faster and cheaper transactions.

• Reducing fraud: CBDCs can reduce fraud and illegal activities due to the fact that these digital currencies are regulated and monitored by governmental bodies and central banks.

• Access to digital payments: digital payments have proved to be growing rapidly and with CBDCs, digital payments can be accessed more easily.

What Are the Concerns Around CBDCs?

Similar to every new and non-traditional technology, there are doubts and concerns surrounding CBDCs. These include the following:

• Security threats: digital currencies, unlike traditional currencies are more susceptible to cybersecurity attacks.

• Loss of privacy: CBDCs are regulated and under surveillance. This, in turn, could create privacy breaches and concerns.

• High costs and challenging operations: implementing CBDC technology can be costly and challenging and can take time.

• Banking competition: CBDCs can disrupt the ongoing financial system and distribution. This is because these digital currencies can threaten the traditional banking sector as it draws investors' attention away from the latter, hence causing traditional banks like Bank of America (BAC) and ING Group (INGA) to lose profits and credit. (Source:Forbes)

How Can CBDCs Affect the Markets and Traders?

Given the aforementioned data and the fact that many central banks and countries are looking into integrating CBDCs into their financial systems, it only makes sense to learn that CBDCs can have a direct impact on the market, investors, and traders alike. However, since this is a relatively new topic, no direct effects have been proven yet. 

Nonetheless, if CBCDs replace traditional payments, commercial banks can be affected negatively, and the value of their stocks can depreciate accordingly. On the other hand, studies have shown that well-designed CBDCs can improve financial stability. In addition, studies indicate that CBDCs can provide central banks and policymakers with updated and current information which can impact their policymaking decisions including interest rates which have direct impacts on the markets.

Also, since CBDCs are monitored and under surveillance, this can increase payment transparency which can decrease fraud and affect market sentiment. CBDCs can also potentially increase market liquidity as central banks can provide investors and traders with more available cash, hence potentially affecting market activity.

Conclusion

To conclude, as more of the world’s global economies seem to be shifting towards digital payments, traders and investors alike may want to learn more about this nascent field which can have potential impacts on the global economy, in general, and their trades in particular.

CBDCs have also drawn the attention of public figures such as Tesla (TSLA) CEO and multibillionaire, Elon Musk, who revealed that he is sceptical about the future of CBDCs which only shows the unpredictability and uncertainty surrounding this shift. Even the Federal Reserve, the biggest central bank in the world and the policymaker for the world’s largest economy announced in 2022 that it intends to develop a bank-to-bank digital currency which only proves the prowess of CBDCs.

On the flip side, others like US President Donald Trump seem to hold a less favourable stance when it comes to CBDCs, calling them “very dangerous,” as he believes that they can cause money to “disappear from people’s bank accounts.” As such, traders will have to see how Trump’s re-election will actually affect this form of payment.

CBDC FAQs:

What is a CBDC?

A Central Bank Digital Currency (CBDC) is a digital version of a country's fiat currency, such as the U.S. dollar or Euro, issued and regulated by a central bank.

How do CBDCs work?

CBDCs are digital representations of national currencies. They are issued and managed by central banks.

What are the two types of CBDCs?

Retail CBDC (CBDC-R) is used for retail and private transactions, and Wholesale CBDC (CBDC-W) is aimed at financial institutions for interbank or wholesale transactions.

How do CBDCs impact financial stability?

CBDCs could improve market liquidity and enhance financial stability by offering central banks more control over monetary policy. However, they could also reduce the role of commercial banks, impacting their stock values.