Cryptonomics: Central Digital Bank Currencies Explained

As the world moves away from cash to a digital money market, it is to be expected that more and more governments will adopt Central Bank Digital Currencies.

By
Ahamdi Abarikwu
on
May 31, 2021
Category:
Cryptonomics

Introduction

When the blockchain financial revolution began in 2009 with the creation of Bitcoin as a digital currency, very few people could imagine how massively it would disrupt traditional financial systems. Most governments didn't pay attention; they probably dismissed it as an animated adventure that will ultimately die down. But as the adoption of cryptocurrencies for means of financial settlement and store of value spread like wildfire, many governments are beginning to appreciate the innovation. They are now taking active steps to stay ahead of the curve rather than remaining perennially antagonistic.

It can be argued that many political authorities felt uncomfortable with some unique issues that came with the use of cryptocurrencies. The problems that stand out the most revolve around cryptos' highly speculative nature and the tendency for rogue elements in the space. Lots of government officials worry about the use of crypto to move illicit funds and other illegal activities. Simultaneously, there are undeniable advantages, such as fast transaction time and very cheap cross-border transfers etc, associated with the use of cryptocurrencies. The effort by regulatory authorities to harness the usefulness of digital currencies while mitigating risks associated with their use, has led to the development of Central Bank Digital Currencies, CBDCs.

What is a CBDC?

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A Central Bank Digital Currency is a digital form of money issued by the Central Bank of a country and backed by both law and a monetary reserve. Hence it is a legal tender in its jurisdiction and, though digital, they possess the full utility that traditional paper/physical fiat does. CBDCs are still in their early stages of development, with none perfected as of yet.

Features of a CBDC

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Though the framework of the operation of CBDCs is still being worked out, some of the features they will possess have already crystallized. Examples of such features are

  1. Centralization

By nature, cryptocurrencies are decentralized and permissionless. Anyone anywhere can carry out a transaction without an intervening central authority. This renders Central Banks unneeded and made governments very uncomfortable. Also, private entities issued cryptos, which means that governments had no control over its dynamics and could not incorporate them into their economic policies. To leverage the advantages of cryptos as a digital form of payment whilst exercising control over it, CBDCs will be mostly issued on permissioned blockchains, giving governments control through their Central Banks.

  1. They will be Legal Tenders

Even though the community has widely adopted cryptocurrencies as a means of payment, they don't have legal status. They can only be used based on mutual community acceptance outside of the written code. In contrast, CBDCs will be backed by law as legal tender and can be used in every financial settlement.

  1. They will be digitally identifiable

Bitcoin in Africa is Bitcoin in the US. It is borderless. The same goes for every other cryptocurrency. On the other hand CBDC issued by a particular country, though usable for cross-border transactions, will have the issuing country's identity programmed into it. This will most likely be digitally different from that issued by another country. Also, to prevent counterfeiting, each unit of a CBDC will have a unique identifier, just like each note of paper money.

  1. They will be convertible

CBDCs will be denominated and pegged to the issuing country's fiat to avoid duplicating currencies in a particular country. The importance of this is that a CBDC will also be readily convertible to cash and vice versa.

Benefits of CBDCs

  1. It will improve transactional efficiency and reduce cost

Like crypto transactions, a CBDC holder can make payments directly to a recipient without going through a bank. Additionally, as can be seen in blockchain technology, the transfer of money in digital tokens is more efficient and less costly.

  1. CBDCs will help governments to curb fraudulent cash movements that cryptos are continually accused of facilitating. It will be possible to keep track of the location of every issued CBDC, and it is expected that that will be a deterrent against its use for illicit purposes
  2. The world is steadily moving to go cashless. CBDCs will be an excellent alternative to cash

History of CBDCs

The innovation that blockchain and crypto brought to the financial space has made many Central Banks and governments explore the integration of CBDCs into their monetary system. While no country has fully implemented CBDCs at the time of writing, many trial projects are currently going on to determine their viability and nuances.

Leading the frontline is China, pushing towards digitization of the Yuan currency as a matter of state policy. This is being done in hopes of furthering the use of Yuan as an international medium of exchange. As far back as 2014, China has carried out several pilot projects in Shenzhen, Suzhou and others. It is safe to say that China is closest to a full deployment of CBDCs as a state-wide digital currency.

Other countries such as the United States of America, Japan, England, Canada, Uruguay, Thailand, Venezuela, Singapore, the Bahamas, Russia, etc., have also launched programs to test-run the CBDC idea. Eventually, many more countries will inevitably join the train as the world steadily moves away from a cash-based money economy to a digital one keeping par with innovation. Further reading about CBDCs can be found here.

Conclusion

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It took the widespread adoption of blockchain and cryptocurrencies for states to notice the innovation and promise that digital currency holds. As the world moves away from cash to a digital money market, it is to be expected that more and more states will adopt Central Bank Digital Currencies as an integral part of their monetary policy. With countries like China at an advanced stage of their trials, it is just a matter of time before we see full deployments worldwide.

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Ahamdi Abarikwu

Ahamdi Abarikwu is an Electrical Engineer and a lover of anything crypto. He is also an avid writer, proofreader and editor. He loves to play Scrabble in his spare time.