Cryptocurrencies have been commended for their potential to usher in a new era of global financial inclusivity and simplified financial services infrastructure. Their popularity stems from their ability to serve as a store of value rather than a medium of exchange. This disparity is slowly closing as both commercial entities and monetary authorities have been issuing stable cryptocurrencies and CBDCs as viable mainstream payment options.
A CBDC, or Central Bank Digital Currency, is a virtual currency that is backed and issued by a central bank. As the popularity of cryptocurrencies and stablecoins has been growing all around the world, central banks have realized that they must provide an alternative to physical money or risk missing out on the future of money
Cryptocurrencies use distributed ledger technology (DLT), which means that the accuracy of a transaction is constantly validated by devices all over the world rather than by a central entity. CBDC transactions are managed on a digital ledger, which speeds up and secures payments between individuals, institutions, and banks.
Central bank-issued digital currencies are currently one of the most innovative concepts in the worldwide financial ecosystem.
A digital currency’s core concept has been around for more than a quarter-century. The first digital currencies were issued by central banks, such as DigiCash in 1989 and e-gold in 1996.
Nonetheless, the introduction of Bitcoin in 2009 significantly altered this model in two ways: It created a currency that was independent of any sovereign monetary authority and established a decentralized ledger for transaction execution and record-keeping.
According to several public statements, CBDCs appear to be more than just a digital-native replica of traditional coins and notes. CBDCs are seen as programmable money by some governments. They consider CBDCs as vehicles for monetary and social policy that may limit their use to specific areas, basic necessities, or defined periods along with addressing the challenge of greater financial inclusion.
There are different forms of CBDCs and all of them come with different implications for monetary policy transmission, payment systems , and the structure and stability of the financial system.
A value-based wholesale CBDC would replace or supplement central bank reserves using a restricted-access digital token. A token is a bearer asset, which means that the sender transfers value directly to the receiver without the use of a third-party during the transaction.
This would be a dramatic change from the current system, in which the central bank credit and debit accounts without actually moving money. The wholesale CBDC is the most popular concept among central banks due to its potential to make existing wholesale financial systems safer, cheaper and faster.
This concept is gaining traction among emerging market central banks as they seek to lead in the rapidly growing fintech industry, promote financial inclusion by hastening the transition to a paperless society, and reduce currency printing and handling costs.
CBDCs would throw a wrench into the current fractional reserve system, allowing commercial banks to create money by lending out more than they have in liquid deposits. Banks require deposits in order to make loans and investment decisions.
The fractional-reserve banking system would be replaced by a narrow banking system primarily overseen by the central bank. That would constitute a financial revolution, with numerous benefits. Central banks would be far better equipped to prevent bank runs and monitor risky credit/lending decisions made by private banks.
A well-designed CBDC will be a secure and unbiased payment and settlement asset, serving as a shared interoperable platform around which the new payment ecosystem will organize itself. It will enable a unified open finance architecture that encourages competition and innovation.
Recently, Monty Metzger was a moderator in the EBC22 where he and the panelists discussed about CBDCs, where he asked some very interesting questions with the speakers like what’s important about Central bank digital currency? Stablecoins unstable situation that we are facing, what’s the initiative of CBDC here?
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