A new form of payment called central bank digital currency (CBDC) is being closely studied by central banks because to the growing interest in cryptocurrencies and the decrease in the use of cash. The value and primary purposes of this new currency will be the same as those of conventional bank notes, coins, and fiat money in general, including value storage, medium of exchange, and unit of account. However, CBDC will also include new functionalities, such the ability to program money using smart contracts, which will add interest rates, limit the money’s validity, and automate payments depending on predetermined criteria.
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What is a CBDC?
The central bank issues digital currency known as CBDC. It functions as an account- or token-based system.
Cash-like CBDCs are token-based. Tokens, often known as “digital cash,” are kept in digital wallets by users, and the quantity of cash in the wallet decreases in proportion to the payment made. The money’s worth is represented by the token, and each token’s validity must be guaranteed.
Account-oriented Similar to digital bank accounts, CBDCs are held by the central bank as opposed to a commercial bank. The value is equal to the account balance, and identification is the main issue as it establishes the proper connection between payers and payees and verifies that the payer has the money to complete the transaction.
What distinguishes a cryptocurrency from a CBDC?
Conceptually, there are many parallels between CBDC and cryptocurrency. Cryptocurrencies all have the same characteristics: ownership based on cryptographic keys rather than accounts; decentralized settlement without the requirement for a trusted counterparty; and the ability to change validity via the use of smart contracts. Given that a CBDC may be created with each of these characteristics, the two are quite comparable.
However, there are variations.
The value and supply of CBDCs are regulated by the central bank as they are typically tethered to the value of a currency (the Swedish e-krona, for instance, is equal to the ordinary krona). In contrast, the value of cryptocurrencies is determined by supply and demand, which results in significant volatility.
CBDCs won’t include the cryptocurrency mining that we now observe. In order to create, distribute, and facilitate transactions with cryptocurrency tokens, it is necessary to solve intricate mathematical equations. However, CBDC transactions may be settled by central banks, who can also disperse the currency to the general public through methods like digital currency exchange for tangible cash.
Nonetheless, cooperation between central banks and other intermediaries is probably inevitable. They lack and most likely don’t want to assume account management and customer-related tasks and responsibilities, such Know Your Customer and Anti-Money Laundering/Combatting the Financing of Terrorism.
Considering that El Salvador is the first nation to accept Bitcoin in addition to dollars as legal money, recent developments there are particularly intriguing. Similar to fiat money, the Salvadorean state assures you that you may use it to purchase anything in El Salvador. This does not imply, however, that Bitcoin will triumph in the long run as a virtual money for developing nations.
In the end, CBDCs could be more appealing to emerging economies as digital currencies than private cryptocurrencies, but only if they are generally accepted as real cryptocurrencies. Similar to adopting the dollar, adopting Bitcoin gives El Salvador access to a potentially more appealing form of currency in the absence of a reliable central bank, but it also entails giving up authority over monetary policy and currency. El Salvador will now be impacted by both US interest rate policy and variations in the value of Bitcoin globally, despite the argument that adoption of the cryptocurrency will lessen the nation’s reliance on the US Federal Reserve.
