Everything You Need to Know About CBDCs
A brand-new type of digital currency is starting to appear. This is the central bank’s digital money (CBDC). We have to conduct digital transformation throughout every industry as a result of COVID-19. Such innovation was pioneered by the finance industry. CBDCs are still a new technology to several people, though.
CBDCs, however, are something that I believe everyone should be aware of. So, you can consider this article as your beginner’s guide to learning everything there is to know about CBDCs.
Table of Contents
What is Central Bank Digital Currency (CBDC)?
To know about CBDCs, we first need to discuss fiat money. Fiat currency is what governments issue in today’s world. No physical commodity like gold or silver backs them. Fiat money is considered a form of legal tender that can be used to interact with goods and services. It is what we use as cash currently as it comes in the form of banknotes and coins. Physical currency is still very much in use. But many countries saw a significant decrease in its use, especially as COVID-19 hit.
Moreover, cryptocurrency and blockchain technology also generated interest in digital assets.
As such, governments are looking for ways to introduce digital currencies. These currencies will have the backing of the government, just like fiat money.
This is where CBDC comes in. A central bank digital currency (CBDC) uses tokens that are based on the blockchain. The difference between this and crypto is that CBDCs will act as digital fiat money. That means it is not fully independent of the laws and regulations of the country.
Unlike decentralized cryptocurrency, a central banking system regulates and manages CBDC.
Further reading: Cryptocurrency vs. Fiat Money: All you need to know
Types of Central Bank Digital Currencies (CBDCs)
Broadly speaking, there will be two major categories of CBDCs:
- Wholesale CBDCs
- Retail CBDCs
A wholesale CBDC will be solely for financial institutions that hold reserve deposits with a central bank. It’ll streamline transactions. Furthermore, it will also eliminate the need for any unnecessary intermediaries.
Both of these factors will reduce the overall risk in transactions.
A retail CBDC will be for the public by the central bank. A retail CBDC will be more efficient than physical fiat money. Plus, it will have more traceability.
Central banks predict that we will initially use CBDCs along with fiat currencies. That implies that initially, we will continue to use the traditional banking system. And even though this will eventually shift to entirely digital fiat money.
The World Economic Forum research states that digital currency will be divided into two categories. This could be a problem. Considering that, in the end, who decides what our financial objectives are and what things we’ll be purchasing with our money? That can suggest a socioeconomic inequality that wasn’t there before.
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Why Do We Need a Central Digital Currency?
There are many reasons for governments to introduce CBDCs. One of them is, of course, to compete with other digital financial options. Cryptocurrency coins fall under this since they are not accountable to any specific authority.
The best example is Bitcoin. Since it has been running continuously since 2009, it demonstrates that a decentralized financial system is not only possible but is also sustainable.
Also, it prevents the problem of double spending, which is a big concern with traditional finance. As the world economy weakened, we observed governments print money with no underlying asset to support it.
Printing too much money lowers the purchasing power and value of money. So, if the government keeps printing too much money, it can become worthless.
CBDC is another avenue that government institutions are looking to move into. They are looking at it as a solution to provide consumers and businesses with privacy, convenience, and financial security.
It is considered as an alternative for cryptocurrencies and their extreme volatility. However another concern is that the government will have authority over CBDCs, allowing it to limit their expansion and have an impact on inflation.
Hence, before CBDC becomes the norm, it’s crucial to consider if we want a third party to have complete control over our money when there are other viable methods of using our money more secretively and securely, like Bitcoin and other decentralized currencies.
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How Will CBDC Influence Our Society?
Whether we like them or not, there are some facts that we have to face, no matter how we think regarding them. One reality is that there is less and less physical money in the world.
In the past few years, we have seen government and central bank intervention like nothing before.
These interventions have caused economic problems such as inflation. Inflation happens when there is an imbalance in the supply and demand of money. We must know where this problem arises from; and what is the underlying root cause.
Many individuals think that the pandemic was what started the financial crisis and inflation. But, if we analyze historical data, going back to 2008 when the Great Recession began, we can see that various governmental institutions and central banks got things wrong that caused the economic downturn, including Quantitative Easing (QE).
As such, they have introduced the idea of CBDCs. It will enable governments and central banks to develop a digital currency with strict regulations.
CBDCs may rely on similar underlying technology as cryptocurrencies. By doing so, they will achieve a certain level of efficiency and trust. But when it comes to centralization and supply, cryptocurrencies and CBDCs are vastly different.
Advantages and Disadvantages of CBDCs
Advantages for Our Society
The governments believe that the adoption of CBDCs will improve our financial sector. Rather than relying on the current financial system, CBDCs will establish a direct link with the users like cryptocurrencies and online payments are currently doing. These options for sending and receiving money; will increase thanks to this direct connection.
Furthermore, CBDCs are to reduce illegal financial activity. Besides that, they can facilitate effective cross-border transactions. But it remains to be seen.
Disadvantages for Our Society
Additionally, CBDC could have a few disturbing consequences on our culture. You won’t be able to conduct business anonymously, for instance. Your spending will always be traceable and trackable by a central authority. There will be zero transparency, and complete traceability will be given.
Central banks may influence our loan decisions if they have more power.
So, let’s consider this situation if an AI software determines that you are not eligible; you might not be able to obtain a loan for a startup or a mortgage.
The capacity to hold actual money in your hands; won’t be available either. So, central banks could use negative interest rates whenever they see appropriate. Consequently, if individuals don’t use their current funds immediately, they risk losing them. As a result, consumer spending would increase without the consumer’s consent.
Beyond that, increased traceability and the introduction of CBDC may have political implications. A government can categorize its citizens and pinpoint the zones where it is underperforming. After that, they can target various stimuli at each of those consumer segments. People who obtain those benefits may subsequently decide to modify their vote as a result.
Role of AI in Central Bank Digital Currency (CBDC)
One significant feature of CBDC sets it apart from conventional digital banking. It also relies heavily on artificial intelligence (AI).
CBDCs will have built-in rules and regulations that will impact every transaction. These regulations may result in money having an expiration date. Also, it can imply that your access to services or goods might be restricted.
In addition to this, central banks can also make use of smart contracts. These contracts will solve problems automatically through the use of self-learning programs. These self-learning programs won’t be tailored just for you. Thus, this might drastically restrict the use cases for CBDC. An AI program’s choice to refuse a transaction could prevent users with particular needs from being able to finish it.
Further Risks of AI in CBDC
By deploying complex AI systems, there can be unintended consequences. Due to the CBDC’s technology’s relatively recent development, several factors might not be considered into account properly.
This will lead to additional issues that could compromise people’s ability to keep their financial stability.
Additionally, in instances where we use AI for cross-border payments, just a small modification to the policies or parameters of a single nation can have a snowball impact. Like in recent years, this might then have an impact on the entire global economy.
Economies, taxes, and interest rates can all shift automatically, causing AI algorithms to alter as well. There is no way for us to predict how an algorithm will respond to a specific change. This further limits your ability to use money.
No nation has formally introduced a central bank digital currency as of yet (CBDC). Governments still have several critical issues to resolve.
But, as we have seen in this post, CBDC will certainly have both advantages and disadvantages as an electronic payment method. But, much like with any revolutionary system, CBDCs’ future is still uncertain.
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