Over the last couple of years, the crypto market has witnessed massive growth in technology and adoption. Especially that now, we have a recent emergence of Decentralized Finance protocols, the ecosystem has transformed into a whole new level of practical and decentralized application. But still, no branch of digital currencies is set to have a more significant impact than Central Bank Digital Currencies. Different nations have so far announced their intention to develop their own digital currencies. The introduction of CBDCs will possibly lead to efficient, robust, trusted, and legal-tender-based payment options.
With that said, in this article, we will discuss everything you would like to know about CBDCs and how they will transform the finance sector. So, without further ado, let’s dive in!
So, what is CBDCS?
CBDCs are like a new-age form of centralized digital currencies that governments are experimenting with and are issued by the different central banks worldwide. CBDCs are governed by the local money authorities of the different countries and are executed either by the central bank’s database or private sector firms. These central bank digital currencies may utilize blockchain technology, but that mostly depends on the frameworks used to implement the digital assets in circulations. CBDCs are expected to use the same distributed ledger technology as cryptocurrencies. However, unlike cryptos like Bitcoin and Ethereum, CBDCs are centralized digital currencies issued by central banks.
Types of Central Bank Digital Currencies
When it comes to types of CBDCs, we can round up that discussion to two distinct models of CBDCs. The two available models are wholesale CBDC and Retail CBDC. In this section, we will explore both of them briefly.
a) Wholesale CBDC
The wholesale CBDC facilitates payments alongside the settlement of transactions among financial institutions. Wholesale CBDCs are traded and exchanged between private banks and central banks. These exchanges help to streamline payments between the institutions. Also, they enable more efficient cross-border transactions and reduce liquidity and counterpart credit risk. Most people consider CBDCs are one of the best projects as they make the existing wholesale financial systems economical, faster, and safer. The two types of wholesale CBDC, according to their implementation, are cross-border payment wholesale CBDCs and Domestic payment wholesale CBDCs.
b) Retail CBDC
The Retail CBDC model focuses on facilitating payments between individuals and businesses. Essentially, this is digital currency meant for the ordinary consumer to make transactions for their day-day activities. Retail CBDC is based on DLT, which offers anonymity, traceability, 24/7 anonymity, and feasibility. Retail CBDC also eliminates the involvement of third parties, which reduces the chances of occurrence of criminal activities. Some of the notable variations of retail CBDC are indirect retail CBDC, direct retail CBDC, and hybrid retail CBDC.
What are the Benefits of CBDCs?
Understanding CBDCs gives you a clear perspective of their significance in the financial sector. The fundamentals of CBDCs also provide you with the appropriate responses for why we need CBDC. They have the potential of transforming the financial industry as we know it. The benefits of CBDCs are an essential requirement that confirms the competitive advantage of CBDCs over other digital currencies. With that said, here are some of the notable benefits of central bank digital currencies.
a) Faster Cross-border Transactions
CBDCs facilitate faster transfers locally and internationally. Transactions are almost instant and require much lower fees than the traditional financial models. And since CBDCs are actual fiat currencies but in digital form, they will drastically minimize the task risk of monitoring and verifying funds in every banking platform. The lower transaction fees and faster transfer rates will also promote economic growth and benefit the lower classes.
b) CBDCs Promote Social Inclusion
CBDCs are expanding the social inclusion scope. Today, a significant part of the world is unable to access financial services. However, things will be different with CBDCS as they are issued via the various central banks but are available through digital wallets. This makes it possible for the unbaked to access and transfer funds without necessarily having private bank accounts. Also, it will benefit the underbanked as they will have higher access to financial services with faster KYC. CBDCs can ensure people gain new perspectives on accessing financial services.
c) Better Efficiency in the Global Payment Systems
Another significant advantage of Central Bank Digital Currencies is improving the efficiency and safety of retail payment systems. In retail payments, CBDCs emphasizes enhancing the efficiency of the payment process. CBDCs enable faster settlement of large-value payments that would otherwise have taken long hours to settle in wholesale transactions. Also, by delivering change, CBDCs are supporting the exclusion of all the low-value coins.
d) Facilitating the Shit Towards Cashless
The other most prominent benefit of CBDCs is the move towards a cashless society. With CBDCs, we will transform into a cashless society that doesn’t have to depend on coins and notes for their financial transactions. CBDCs are presenting a more favorable alternative than ATM cash withdrawals. And now the fact that CBDCs are backed by the Central Banks, people are more likely to trust them.
How Do CBDCs Impact Cryptocurrency?
Many governments across the world are willing to experiment with Central Bank Digital Currencies. This will likely enhance the mass adoption of cryptocurrencies in their territories. That’s because CBDCs promote financial inclusion and make cryptos easier to access and invest in. Newcomers to digital finance can also access their first wallets and experience some of the perks of digital assets through CBDCs. What's more, CBDCs will promote seamless cross-border payments and international availability, facilitating faster and easier transactions in the crypto landscape.
Are there any Risks to the Adoption of CBDCs?
The future seems promising with the implementation of CBDCs. However, one of the significant downsides to CBDCs is privacy concerns. The transition to an entirely cashless banking system imposes severe privacy concerns due to its centralized nature. Central banks, in this case, will be able to monitor every transaction that’s performed via the CBDC. This leaves a lot of room for debatable monetary policies.