Everything you need to know about CBDC

Central bank digital currency (CBDC) is a digital token created by a nation's central bank, which is pegged to the value of a country's legal tender (such as the US dollar, euro, or yen).

Unlike decentralized cryptocurrencies, CBDC is issued and controlled by central banks to ensure its stability and reflect the value of traditional currency.

CBDC provides a digital alternative to physical currency, functioning similarly to prepaid cards or digital wallet balances, but without the need for third-party intermediaries such as commercial banks. Although many countries are still in the early stages of CBDC model development, there are still some important considerations, such as accessibility, privacy, yield potential, and the potential for completely replacing cash.

As society moves towards digital payments, the demand for alternative financial services is growing, especially among unbanked populations. CBDC aims to fill this gap by providing direct access to central bank funds, eliminating reliance on intermediaries, and potentially lowering the cost of cross-border transactions. They can also reduce the risk of bank failures and simplify monetary policy.

The COVID-19 pandemic has accelerated the shift from physical cash, prompting governments and financial institutions to explore digital alternatives. The main goal of central bank digital currency is to provide secure, convenient, and efficient financial services for businesses and consumers, enhancing privacy, convenience, and financial inclusion.

The introduction of CBDC is aimed at addressing the rise of private electronic currency systems such as digital wallets and cryptocurrencies. Unlike highly volatile cryptocurrencies, the design goal of CBDC is stability, government backing, and it is intended for everyday transactions, thereby ensuring its status as legal tender.

Although central bank digital currencies (CBDC) are often compared to cryptocurrencies, there are key differences between them. Cryptocurrencies operate on decentralized networks, lack government support, and their value is driven by market sentiment. In contrast, CBDCs are centrally regulated, stable, and linked to the value of national currencies, making them suitable for widespread adoption in the financial system.

CBDC is mainly divided into two categories: retail CBDC and wholesale CBDC. Retail CBDC is aimed at the general public, supporting peer-to-peer payments, online transactions, and inclusive finance. Wholesale CBDC aims to improve the settlement efficiency of financial institutions and large enterprises, addressing liquidity and counterparty risks.

When designing a CBDC, central banks must choose between two main structures: a token-based system or an account-based system. A token-based system offers a higher level of anonymity, relying on cryptographic keys; while an account-based system is linked to the user's bank account and requires personal identification and compliance with regulatory standards such as "Know Your Customer" (KYC) and Anti-Money Laundering (AML).

The implementation of CBDC can lead to a more streamlined and secure payment system, reducing fraud and facilitating faster transactions. However, the centralization of financial control may raise concerns about privacy and government surveillance. Additionally, cross-border payments may become more efficient, although challenges related to legal and regulatory issues need to be addressed.

Some countries have begun to explore the potential of CBDCs. For example, China's digital yuan is undergoing extensive testing and has launched pilot projects in multiple regions. The United States is also studying the feasibility of a digital dollar, with the Federal Reserve collaborating with banks such as Citibank and Wells Fargo to assess its potential benefits and risks. The European Union is developing a digital euro, which will provide a stable, government-backed alternative to private digital currencies. Sweden's e-krona project and the Bahamas' Sand Dollar are also examples of CBDCs being advanced.

With the continuous development of central bank digital currency (CBDC), its potential to reshape the global financial landscape is becoming increasingly prominent. They can provide safer and more efficient alternatives to traditional payment systems, promote financial inclusion, and support the digitization of the economy. However, the comprehensive impact on monetary policy, financial stability, and privacy remains uncertain, requiring ongoing research and careful consideration by central banks around the world.