What is a CBDC?
CBDC stands for Central Bank Digital Currency. It is also a type of crypto coin but it is issued under the supervision of a Central bank using a private blockchain. A CBDC is a digitized version of a legal tender such as Euro, Yen, or USD etc. Just like fiat currencies the value of a CBDC is monitored and controlled by the Central Bank.
Central banks hailing from several nations around the globe are testing and developing their native CBDC projects. There are some places where CBDCs are already established. However, some regions are still in the testing phase and running pilots.
Working Mechanism of CBDCs
Gold standard was abolished for fiat currencies by President Richard Nixon in 1971. It means that fiat currencies are no longer backed by gold reserves in Central Banks. In the same manner, CBDCs are not backed by gold or silver reserves.
The central bank that issues the CBDC can increase or decrease the total circulatory supply at their discretion.
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At the same time, a CBDC is considered a legal tender equivalent meaning that it is used for all trades and acceptable as unit of account in the region. Financial institutions and Central bank can implement credit-based models using CBDC infrastructure.
Types of CBDCs
Here are some common classifications of CBDCs mentioned as under:
Wholesale CBDCs are used for international trades and transactions. These are secured as reserves at the Central Bank and allow financial institutions, brokers, and regional banks to make credit and debit requests from importers or exporters through Central Banks.
It means that Wholesale CBDCs are used for interbank transactions. Central banks may implement monetary policies using wholesale CBDCs such as minimum reserve requirements or applicable interest rates.
Retail CBDCs are issued for the use of the citizens and businesses that are working within the jurisdiction of a nation.
They are used in place of a fiat currency or the legal tender in the region. It means that they are used as unit of account in the country just like fiat currencies. There are two sub-types of retail CBDCs given as under:
Token-based CBDCs work like a token and they are accessible using a combination of private and public keys. In this manner, the users are able to perform transaction in a secure and anonymous manner.
Account-based CBDCs require the consumers to use digital identification in order to access their reserves.
Advantages of CBDCs
Here are some important benefits of CBDCs mentioned as under:
Reduced Credit and Liquidity Risks
CBDCs remove the credit and liquidity risks such as bank runs that are associated with fiat currencies. In this manner, they are more secure for institutional users such as private financial firms, brokers, asset managers, and online merchants.
CBDCs operate on a private blockchain network that reduces their operating costs to a considerable degree.
Therefore, the users on this network can make transactions at a lower cost in comparison to the traditional remittance and foreign exchange platforms. At the same time, the transactions on CBDC networks are faster and more secure.
CBDCs strengthen the value and role of as an international reserve currency.
CBDCs bring greater financial inclusion across the globe. People can easily access their CBDC reserves using government-sanctioned mobile applications on their smart phones.
In this manner, the unbanked individuals may also access a greater array of financial services at one-click in comparison to the existing fiat currency system.
CBDCs are accessible for general public as the development of internet and mobile-phone based economy has given rise to reduce in demand for physical cash.
People have become more aware of cash-less services which means that there are little constraints when it comes to implementation and mass adoption of the token.
Disadvantages of CBDCs
Here are some risks associated with CBDCs:
- It requires changing the current financial network.
- Implementation of monetary policy can lead to unknown impact or risks using CBDCs.
- Privacy and Protection for people and institutions who are using CBDCs is a big concern.
- The project can be subjected to cybersecurity and technical problems.
CBDC is a nascent technology, financial experts, legislators, researchers, and economists are still working out ways to identify its benefits and risks.
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