CBDCs are seen as a reaction by governments to the growing popularity of cryptocurrencies, but even they also have nagging concerns.
Before the advent of blockchain and bitcoin, fiats mainly were the only legal tenders. These fiats were issued and managed by the Central banks of respective countries of the world. Some fiats are more powerful than others to the extent that they are used as the unit of measurement of wealth and as reserves across different economies.
With bitcoin, the concept of money changed and with the rise of other types of cryptocurrencies, money as we know it keeps changing. El Salvador and the Central Africa Republic have responded differently to cryptocurrencies by making bitcoin a legal tender. However, other countries around the world have responded differently and taken a different approach. The introduction and proposed introduction of Central Bank Digital Currencies(CBDCs) is the way other countries across the globe have chosen to respond to the growth of cryptocurrencies.
A central bank's digital currency is a digital representation of government-issued fiat currency (CBDC). This type of virtual money is issued by a central bank and is linked to the currency of the country in which it is used. The main distinction between a CBDC and other currencies is that its supporters believe it will be able to use innovative payment technology, most notably a blockchain, to increase payment efficiency and reduce transaction fees.
The cryptocurrencies most similar to CBDCs are stablecoins, which are cryptocurrencies that are tethered to fiat money and strive to maintain the same value. The primary distinction is that CBDCs are issued by national governments all over the world.
The CBDC is backed by the federal government and issued by the country's central bank. The CBDC is then legal tender and can be used to pay employees and purchase goods and services. This may appear to be a familiar scenario. After all, you can transfer money electronically from your bank account to a friend's account at another bank.
However, with a CBDC, this type of transaction would not have to go through multiple institutions or take several days. It could all happen almost instantly on a single digital ledger. A CBDC would not also necessitate the use of a commercial bank account. CBDCs would provide a way for unbanked individuals to transfer money digitally.
The creation and issuance of the digital currencies fall within the purview of the Central Banks of respective countries. This means that the whole process of issuance and monitoring will be controlled by the Central Bank and, by extension, the government. This goes against the ethos of crypto and blockchain, which seeks to make sure that such power is not concentrated in the hands of a central body. The centralised nature of the CBDCs means that, just like their fiat counterpart, it is open to manipulations.
Apart from decentralisation, bitcoin and other cryptocurrencies provide users with anonymity. Users can conduct transactions with blockchain and cryptocurrency without fear of their identity being revealed. Users are concerned that the issuance and management of CBDCs by Central Banks will eliminate the anonymity available with other cryptocurrencies.
CBDCs fundamentally contradict the crypto ethos, and they indicate a very real threat to privacy that should be taken seriously. Furthermore, CBDCs expose a flaw that could jeopardise the security of crypto transactions. A CBDC built on the blockchain is transparent, and authorities such as government agencies or police could theoretically access the CBDC's financial data and reveal information about its citizens. Governments will no longer need to exert coercive influence over intermediary financial institutions because they will have direct control and access to individuals' financial lives.
Concerns have been raised about how CBDCs can be best implemented in various countries. CBDCs have been proposed as an infrastructure tool, which means that they will only be used by international monetary organisations and central banks. The other implementation idea is to replace all currencies with new digital currencies. The concern with the latter is that citizens with limited or no internet access will be at a disadvantage. The implication is that the number of unbanked people will also rise. CBDCs will have little impact on citizens' daily activities as an infrastructure tool.
One of the drawbacks of digital currencies is that they can only be used in the issuing country. This means that the e-Naira, which is the digital currency of Nigeria, can only be spent within the country. Compared to the likes of bitcoin, for example, the restriction placed on CBDCs makes it lose its appeal. This might change, and systems might be implemented to allow the trading and swap of digital currencies.
Because central banks are going to be the only ones authorised to issue digital currencies, and because this will make them direct competitors of payment service providers, traditional banks may see a decline in their revenue. Similarly, the demand for consumer deposits may decrease if there is a new type of investment opportunity. As a result of this, banks may lend less money to the economy, which will slow overall economic growth.
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