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?

What Is a CBDC and What Are the Different Types of CBDCs? 

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.

Furthermore, it is important to note that there are two main types of CBDCs; retail CBDC (CBDC-R) and wholesale CBDC. Whereas the former is meant to serve retail and private transactions, wholesale CBDC (CBDC-W) is aimed at specific financial institutions like interbank or wholesale transactions. 

CBDC VS. Cryptocurrency

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 and these are 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 decentralized 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 authorized blockchain while Cryptocurrencies operate on a decentralized one.

Where Are CBDCs Currently Used?

While CBDCs are relatively a new and nascent concept, according to the Atlantic Council of United States’ data, as of 2023 over 100 countries are exploring digital currencies, with the combined economy of these countries representing more than 95% of the world's GDP.  Moreover, there are more or less about 11 countries that have fully implemented and created their own CBDCs. These countries are the Bahamas, Nigeria, Jamaica, Anguilla, Saint Kitts and Nevis, Antigua and Barbuda, Montserrat, Dominica, Saint Lucia, Saint Vincent and the Grenadines, and Grenada. 

What Are Some of the Planned CBDCs?

It seems that more and more countries are shifting to CBDCs and will continue to do so throughout 2023 and the future. Accordingly, data suggests that over 20 countries, including Korea, Brazil, Russia, and Thailand will shift to CBDCs and will begin pilot testing them. In addition, as of 2022, all G7 countries moved to develop CBDCs. As for G20 countries, about 18 of the 20 are advancing CBDCs in 2023. 

Moreover, since January 2023, the Central Bank of The Bahamas, the Eastern Caribbean Central Bank, the Central Bank of Nigeria, the Bank of Jamaica, and the Reserve Bank of India have launched their CBDCs and the European Central Bank (ECB), which is the Eurozone’s central banking system, is likely to test CBDCs in 2024. Other countries are also weighing this option and conveying an interest in digital currencies. 

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, there are no direct effects proven yet. 

Nonetheless, in case CBDCs come to replace traditional payments, then 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.

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 skeptical 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.