Central bank digital currencies are a digital representation of a country’s fiat currency. It is practically a government issued cryptocurrency designed to replace the traditional physical form of fiat currencies.

The term CBDC is broad because its implementation involves many critical decisions by the issuing central bank. The main decision is whether central bank digital currency should be a public purpose because it is available to the general population. If not, the issuing authority may choose to make it available for “wholesale” transactions, meaning that the central bank’s digital currency is only used for settlement between banks. Finally, central bank digital currency can only be used in central banks.

In its research paper, which delves into central bank digital currencies, the Bank for International Settlements (BIS) defines these categories using a Venn diagram called “Money Flower” (see below). The gray area represents different types of CBDCs, while Bitcoin (BTC) and other cryptocurrencies are proprietary digital tokens.

Money flower: classification of money

What is the background of central bank digital currencies?
According to the Bank for International Settlements (BIS), the idea of ​​digital central bank currencies has been around for many years, more than two decades before Bitcoin. However, the concept has grown in importance in recent years. This is mainly due to advances in fintech, including developments in blockchain technology that allow the issuance of digital tokens that represent a store of value.

Additionally, the move to digital central bank currencies supports the general trend towards a more cashless society. In countries such as South Korea, China and Sweden, cash is on its way to becoming a redundant payment method.

What are the benefits of CBDCs?
Central bank digital currencies offer several advantages that can be compared to the advantages of cryptocurrencies such as Bitcoin. Bank opening hours limit the availability of transactions, while central bank currencies can be available for transactions around the clock. Banks can reduce their reliance on clearinghouses, which will save costs.

Like cryptocurrencies, central bank digital currencies could be available to anyone with a smartphone, which will help improve financial inclusion, especially for people in rural areas who do not have access to physical banking infrastructure such as ATMs. In countries like Kenya, financial inclusion has already improved due to the popularity of M-Pesa, an SMS-based cashless payment app.

There are benefits to using central bank digital currencies other than the general benefits of digital currencies. Central banks spend money to print money. The average cost of minting one dollar bill is approximately $ 0.077 per bill. Cryptocurrencies are cheap or sometimes free once you put in the base code.

Central banks can also directly implement monetary policy with a central bank digital currency. This could mean that interest is paid on the tokens themselves and not on bank deposits.

Finally, governments may find it easier to use central bank digital currencies to distribute cash to citizens. For example, COVID-19 has caused a crisis that has caused the United States government to issue economic impact payments in the form of checks and debit cards, which are vulnerable to theft and fraudulent use. With CBDC, the government can spend aid money directly.

What are the risks of digital central bank currencies?
In addition to the various advantages, central bank digital currencies pose significant risks to central banks, governments, and individual citizens.

Perhaps the biggest risk is cybersecurity. China’s efforts to test CBDC have already been hijacked by the scammers, which is alarming as the full version has yet to be officially released. The risks of a network attack or creating new fraud or money laundering vulnerabilities are a real concern for any central bank looking to initiate central bank digital currencies.

On the other side of this risk is privacy. The more the government knows who is using the central bank’s digital currency, the cybersecurity risk can be reduced. However, if citizens feel that the use of CBDC may mean that the government can override the limits of privacy rights, it may not be adopted.

While governments can use a central bank digital currency to implement monetary policy, the new opportunities that arise from them can bring with them some risks. For example, using a central bank’s digital currency to collect negative interest rates in times of crisis could fundamentally change economic models and make storing their wealth in new digital money very expensive for citizens.

Source: CoinTelegraph