What to know about CBDCs in crypto

Central bank digital currencies (CBDCs) are a hot topic in the crypto world right now. The assets are in the spotlight especially in recent days as President Joe Biden demonstrates interest in a U.S CBDC launch.

Nigeria became the first African country to officially launch a sovereign-backed digital currency pilot when the Central Bank of Nigeria (CBN) launched on October 25, 2021. Nigeria’s CBDC is regarded as the second largest behind China’s digital yuan.

At the moment, several countries are in varying stages of implementing and using CBDCs. China has one of the most-promising CBDC infrastructures in the world. Its digital yuan is currently available to citizens in a trial run. Other countries piloting CBDCs include Saudi Arabia, South Africa and Malaysia. Bahamas has also launched its own CBDC and Russia rolled out its CBDC pilot earlier in February.

But what is a CBDC in crypto, and how do they work?

A CBDC is a cryptocurrency that central banks distribute for use instead of a fiat currency. Often these coins are pegged to the value of the underlying fiat asset. In the case of a U.S CBDC, coins would likely mirror the U.S. dollar.

Fiat money is a government-issued currency not backed by a physical commodity like gold or silver. It is considered a form of legal tender that can be used to exchange goods and services. Traditionally, fiat money came in banknotes and coins. Technology has allowed governments and financial institutions to supplement physical fiat money with a credit-based model in which balances and transactions are recorded digitally.

The introduction and evolution of cryptocurrency and blockchain technology have created further interest in cashless societies and digital currencies. Governments and central banks worldwide are exploring the possibility of using government-backed digital currencies. When, and if, they are implemented, these currencies would have the full faith and backing of the government that issued them, just like fiat money.

The main goal of CBDCs is to provide businesses and consumers with privacy, transferability, convenience, accessibility, and financial security. CBDCs could also decrease the maintenance a complex financial system requires, reduce cross-border transaction costs, and provide those who currently use alternative money transfer methods with lower-cost options.

Another ugly aspect of CBDCs is that they centralise money even more and preserve the oligopoly power of financial institutions. Unlike cryptocurrencies that aim to democratise and decentralise finance, CBDCs grant near-complete control to central banks. And, while cryptocurrencies like bitcoin are decentralised, unregulated and unbacked, CBDCs are regulated, centralised and backed by a central bank (the regulator). Central banks can conceivably use their new digital toolkits to monitor, record, analyse and tax every transaction.

A CBDC also provides a country’s central bank with the means to implement monetary policies to provide stability, control growth, and influence inflation.

Central bank digital currencies would also reduce the risks of using digital currencies in their current form. Cryptocurrencies are highly volatile, with their value constantly fluctuating. This volatility could cause severe financial stress in many households and affect the overall stability of an economy. CBDCs, backed by a government and controlled by a central bank, would provide households, consumers, and businesses with a stable means of exchanging digital currency.

The controversies

Of course, there are many blockchain enthusiasts who believe CBDCs are a worthy effort. Accounting giant – https://www.linkedin.com/company/deloitte is one institution that backs CBDCs. The company recently released an analysis in which it theorised how Bitcoin can help usher in CBDCs to replace traditional banking.
Supporters believe that CBDCs promote fiscal inclusion. Some economists even believe that CBDCs could bring an end to physical fiat currency. These cryptocurrencies can also simplify fiscal policymaking. If banking was entirely digital, it would be easier to implement new policies.

However, there are also a number of sceptics. Critics of CBDCs claim widespread adoption of the technology can lead to destabilisation of the global financial market. Others argue that CBDCs will allow government and banking institutions to have more control over clients. Just like the case in Nigeria and China.

Bottom line

CBDCs are a certainty as global digitisation demands innovation from central banks. The benefits for central banks are straightforward: Firmer control, outstanding tracking and monitoring capabilities, the ability to quickly implement monetary policy measures, and the power to counter the growing influence commanded by fintech and financial institutions. On the other hand, CBDCs means direct competition between centralised and decentralised currencies. The government looking to win can ban or limit digital currencies.

Whether CBDCs are bad or good for cryptos remains in the balance. Only time will tell whether CBDCs are good or bad for cryptocurrencies.