What is the difference between cryptocurrency and a central bank digital currency (CBDC)?
The term “digital currencies” is on everyone’s lips. Primarily due to cryptocurrency, which istype of digital currencyCryptocurrency is enjoying widespread popularity and has become a fully-fledged part of the financial world. Its prospects attract both private investors and businesses.
But digital currencies aren't just crypto. For example, when discussing new financial models, the acronym "CBDC" is often used.
In this article, we'll explain how crypto differs from CBDCs—central bank digital currencies.
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Where is cryptocurrency used as a means of payment?
Demand for cryptocurrency has increased primarily due to the widespread migration of payments online. It allows payments to be made on more favorable terms.
However, the use of cryptocurrency as a digital representation of value is very rare. One of the main reasons is its high exchange rate volatility, which complicates stable pricing of goods and services.
Crypt -namely Bitcoin (BTC)— is recognized as legal tender in only a few countries:
- in El Salvador - from September 2021;
- in the Central African Republic (CAR) - from April 2022.
Brazil joined the bloc a few days ago. Bitcoin will be accepted as both a means of payment and an investment asset. The law, signed by the country's president on December 21, 2022, will take effect 180 days later.
Furthermore, Colorado became the first state in the US to accept cryptocurrencies (BTC, ETH, BCH, LTC) for tax payments via PayPal. American states are competing to be the most crypto-friendly jurisdictions as they seek to attract workers and businesses from the emerging remote economy.
CBDCs are the antithesis of decentralized currencies.
Until recently, central banks viewed digital currencies with great caution. Traditional financial institutions viewed them as limited in size and scope, and not fully relevant to monetary policy and financial stability.
The emergence of non-state digital currencies (including cryptocurrencies) and their rapid development has demonstrated the potential of virtual tokens, distributed ledgers, and smart contracts.
There were even concerns that cryptocurrencies could cause significant damage to national currencies and significantly undermine the monopoly of banks and international payment systems on payments.
In practice, cryptocurrencies have so far succeeded in becoming a medium of exchange, but not a measure of value. In a global sense, they have not yet fully acquired the function of money.
CBDCs can be considered the antipodes (and even “ideological enemies”) of decentralized currencies (cryptocurrencies).
The concept of CBDC is gaining popularity
The concept of central banks creating their own digital currencies has now gained attention. Currently, approximately 90 countries (accounting for over 90% of global GDP) are exploring the possibility of issuing and implementing CBDCs.
Where are CBDCs already being used?
Currently, CBDCs are fully operational in ten countries worldwide. National CBDCs were first declared legal tender in October 2020 in two countries—the Commonwealth of the Bahamas and Cambodia.
In 2021, the list of countries that officially began using CBDCs was expanded to include seven countries from the Organization of Eastern Caribbean States (OECS) monetary union.
Which countries are actively developing their CBDC projects?
Japan, Thailand, Australia, and the Philippines have made varying degrees of progress in creating their own version of CBDC.
In the US, they started in November 2022testsystem for a "dollar without banknotes" (e-dollar).
Ukraine has also launched a draft e-hryvnia concept. In October 2022, the Ukrainian Institute of Intellectual Property (UKRPATENT) registered the "e-hryvnia" and "e-hryvnia" trademarks, which belong to the National Bank.
On November 28, 2022, the NBU presented a draft e-hryvnia concept to representatives of banks, non-bank financial institutions, and the virtual asset market for discussion and feedback.
As we can see, many countries around the world have shown interest in creating digital forms of national currencies that will complement cash and non-cash forms of money.
This indicates that significant changes in money circulation, foreign exchange transactions, and monetary policy may occur at the global level in the coming years.
What is a central bank digital currency (CBDC)?
A central bank digital currency (CBDC) is a digital form of a state's fiat currency.
Instead of the forms of money familiar to modern people (coins and banknotes), central banks of some countries are willing to issue money available only in digital form. This money is backed by the full trust and credit of the government/central bank of the issuing country.
For cybersecurity reasons, it is unlikely that CBDCs will be based on public blockchains that anyone can join.
CBDCs are expected to complement conventional cash or even replace it with digital equivalents. Consequently, their issuance will be controlled by central banks, as is the case with fiat currencies.
It inevitably follows that their value will be determined by the value of the national currency.
Finally, a CBDC may not be a monetary equivalent at all in the sense that ordinary consumers understand it. Several studies have analyzed the possibility of using a CBDC solely as a means of settlement between central banks, without issuing it for public use.
Key differences between CBDCs and cryptocurrencies
- CBDCs use a permissioned blockchain network, while cryptocurrencies use a permissionless one.
- The identity of CBDC users is known, while cryptocurrency users remain anonymous.
- CBDCs can only be used for payments, transactions, and other wholesale operations, while cryptocurrencies can be used both for payments and as speculative investment assets.
How are CBDCs different from cryptocurrencies?
While sovereign digital currencies can replicate some of the features of crypto using blockchain technology, they will not be able to fully realize the most attractive features of cryptocurrencies – anonymity and decentralization.
CBDCs are controlled by the issuer, which can be either a central bank or a government. The issuing authority determines the rules for its CBDC. However, it doesn't necessarily have to be based on blockchain or any other type of distributed ledger technology, although in some cases this is the case.
For example, China is actively developing the concept of its own version of a CBDC called the "digital yuan" (e-CNY). Is e-CNY a cryptocurrency? No. The digital yuan is a type of central bank digital currency issued by the People's Bank of China (PBOC). It is an exact analogue of the paper yuan. Therefore, it is not a decentralized currency: e-CNY does not operate on a blockchain.
Why don't central banks just use cryptocurrencies?
One of the most well-known problems with crypto is volatility. While stablecoins offer a promising alternative, recent crypto market news suggests they aren't entirely reliable either. Therefore, simply importing cryptocurrencies into the economy and radically changing the traditional banking system is neither straightforward nor practical.
CBDCs are similar to stablecoins. They are regulated and will likely be backed by a reserve asset (fiat, gold, or other assets) to maintain their value.
Conclusion
CBDCs are, in some ways, the opposite of cryptocurrencies, as they are developed and controlled by central authorities. However, CBDCs could bring the world closer to digital currencies, which could then pave the way for further cryptocurrency adoption.
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