Central Bank Digital Currencies: All You Need To Know
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The world of finance is changing at an enormous speed every single day. For the most part, money is becoming more decentralized than it used to be. However, there are innovations like the central bank digital currency (CBDC), that focus more on being tied to a central banking system.
CBDCs are expected to be the next best thing by government-backed institutions. Indeed, at first look, it may seem exciting that the government is joining the crypto environment.
But what does the future hold for us in terms of finance and CBDCs? Will the benefits outweigh the challenges when central authorities join the fun?
Table of Contents
What is the Central Bank Digital Currency (CBDC)?
A Central Bank Digital Currency (CBDC) is set to be a digital form of money. It is currently in experimentation mode by some central banks. It is expected to replace physical cash and be controlled by the central bank and the FED.
Bitcoin was introduced as a result of the financial crash of 2008 as a way to form decentralization of money. With the idea of cryptocurrencies getting so popular, governments want to join in and follow in their footsteps.
Several countries, including China, and Nigeria have already begun their CBDC trials. Additionally, the European Central Bank and the Bank of England are preparing to be part of the digital system.
How Does the CBDC Work?
Every CBDC is a representation of a country’s fiat money. It works the same way but in digital form.
The technology behind the CBDC differs from country to country. In some cases, they are run on a distributed ledger technology that a central bank manages.
The basic model of CBDC, though, is similar for all countries. For every country, the central bank issues the CBDC. It has the backing of the federal government. You can then use that digital currency for buying goods and services.
You may think that this is similar to a blockchain. However, CBDCs are not like blockchains at all. Unlike Bitcoin, a single authority controls CBDCs entirely. This works against the very idea of crypto which promotes anonymity and privacy.
What are the Advantages of CBDC?
CBDCs can have several advantages that can benefit millions of people.
Firstly, central banks can conveniently increase financial inclusion similar to how Bitcoin already does. This means people who couldn’t participate in financial banking before, due to certain limitations, can now create an account and store funds in it digitally.
Secondly, companies that transact in local currencies will have to be more transparent. This would work to reduce corruption and other illegal financial activities.
Thirdly, CBDCs can address other systematic faults in our banking systems, such as reducing money laundering.
But as good as the above points sound, some serious drawbacks can occur due to CBDCs.
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What are the Disadvantages of CBDC?
1) Loss of Freedom
The biggest threat of completely digital centralized money is the loss of your freedom. Since the CBDC will not be decentralized, government institutions will have full control over all of your money.
What if you want to make a purchase that is important for you but, for some reason, is not authorized by the government?
What if you want to tip someone for a chore they did for you?
Going fully digital with our financial system would mean that the government will decide whether you make or receive payments or not.
This also separates it greatly from Bitcoin.
Bitcoin is unique. It is permissionless and decentralized – both of which CBDC won’t be.
2) Loss of Privacy
Another critical factor that the CBDC will negatively impact is our privacy. It will provide the government with new ways to control citizens by tracking every purchase.
They will be able to monitor, track, and record every single transaction you make. They will also be able to stop a transaction and you will have no other alternative to send or receive money.
Not only that, but CBDC can enforce negative interest rates on everyone. This means that the government will be able to charge interest on the money in your digital wallet as it pleases.
This also creates the possibility that the government can spend in a deficit and transfer the funds directly to its citizens, causing inflation. This way they can avoid distresses like national debt at the expense of its citizens.
As news reports have indicated lately, the government has been printing an excess of fiat money with no underlying asset covering it. This has resulted in the current inflation and economic crisis due to a disparity in supply and demand that the government has too much control over.
With the CBDC being just the digital version of the fiat currency and the government has full control, will things be any different? Can we truly trust CBDC more than the fiat currency when, at the end of the day, the control lies in the hands of a central entity?
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Will CBDC Replace Cash?
Our future will inevitably be cashless. There will be more of a dependence on digital payments. But the entire elimination of cash will not occur all of a sudden. It can be that both CBDC and cash co-exist with more dependence on digital currencies.
Introducing this new digital coin will take a while. We can see the world around us already adapting to digital money as we are seeing the emergence of artificial intelligence, 5g, Metaverse, digital assets, and much more in our daily lives. We are at the beginning of a digital world.
Is CBDC a Good Idea?
There is no doubt that our financial system is increasingly becoming digital. Subsequently, living in a cashless world is a real possibility. Undoubtedly, it is going to make finances a lot easier and more convenient to do everything online.
But an entire dependence on centralized digital currencies will not be a perfect idea.
As mentioned above, the CBDC will come with its fair share of disadvantages, including security threats from intruders.
They may also increase wealth inequality as the rich will be more capable than others of taking advantage of investment opportunities and gaining more benefits.
Furthermore, people living in marginalized areas have limited digital access. Many also lack financial literacy. Digital changes could harm these individuals.
CBDC can be a good idea if we use it alongside cash or another kind of tangible asset. On its own, though, it can do more harm than good if not approached carefully.
The Bottom Line
As cryptocurrencies and Bitcoin are gaining popularity as digital assets, the world’s central banks are realizing the importance of gaining back control. Defi and Fintech companies offer better financial inclusion to people globally. To catch up with them, the government is introducing CBDC. They view CBDC as an alternative payment tool that will hopefully limit people’s reliance on decentralized digital assets.
CBDCs can be a great replacement for highly volatile cryptocurrencies. However, before it is implemented on a large scale, governments and banks need to prove that it provides more security and reliability than Bitcoin.
In the end, what is important is that whatever change occurs, it is done so mindfully and carefully by government institutions so as not to harm its citizens. It all comes down to how CBDCs are managed, designed, and controlled by the governing bodies.
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