While the idea of central bank digital currencies (CBDCs) is an exciting one for many people who have used cryptocurrencies like Bitcoin, it’s not yet clear what kind of role a central bank digital currency would play.
The Bank of England announced plans to launch a digital pound back in 2020 and other experiments are taking place around the world. But how do they differ from regular cryptocurrencies like Bitcoin? And how likely is it that any country would adopt this type of currency?
The idea of central bank digital currencies (CBDCs) is an exciting one for many people who are active in the crypto world.
In essence, CBDCs are digital currencies proposed by some governments and central banks to replace existing payment systems. The motivation is clear: to make digital transactions and transfers easier, the central bank creates widely used digital coins rather than issuing money. These new payment systems differ to their fiat money counterparts in that they’re not intended to be spent like regular money; instead, they serve as tools for transferring value between parties without having to rely on third-party intermediaries such as banks or credit card companies.
Central banks have been experimenting with blockchain-based systems for decades. In fact, the Bank of England was among the first institutions to explore their potential use in facilitating interbank settlement of securities trades. In 1997 a “Multilateral Consensus Securities Settlement System” (MCS) was based on a shared ledger that kept track of all transactions between participating members, but it never went live due to concerns about confidentiality and scalability issues. Today’s central banks are more focused on developing cryptocurrencies as an alternative means of payment.
You can think of central bank cryptocurrencies as a type of digital currency that’s only valid within a small, closed economy. For example, if you live in an isolated island community and all your neighbours are also on the island, then it would make sense for everyone to use their own local currency when trading goods and services with one another. But if those same people tried to use their local currencies outside that community, it may be deemed useless because no one else accepts it as payment.
Similarly with CBDCs: they won’t be used by anyone outside of banks or other financial institutions because they aren’t widely accepted or backed by anything tangible like gold reserves (which is what makes them “fiat”).
Central banks have been exploring how they might issue their own digital currencies (CBDCs). Some countries have already started testing these out: for example, Ecuador has launched its own state crypto called Dinero Electronico; China has announced plans for its own ‘digital yuan’; while Russia is said to be developing its own CryptoRuble.
CBDC efforts are expanding globally for a variety of reasons. First, the COVID-19 problem hastened the decrease of cash use by causing a shift in payment habits toward digital, contactless payments, and e-commerce in response to the pandemic. Second, cryptocurrencies created by unofficial groups or private companies such as Bitcoin have experienced tremendous growth and value increases. In response, 87 nations—representing over 90% of the world’s GDP—are presently investigating central bank digital currencies, and nine of them have already completely implemented a state-owned digital currency.
CBDC vs. cryptocurrencies: The discussion rages on
Digital currencies issued by major central banks are inevitable. What effect will that have on cryptocurrencies? Some commentators are unsure if it will displace other cryptocurrencies.
The technologies underlying CBDC, or central bank digital currencies, and cryptocurrencies may sound similar to those who are not familiar with them. After all, they also constitute forms of digital currency. But to confuse the two is completely false. Even if CBDCs include distributed ledger and blockchain technology into their designs, neither decentralised finance (DeFi) nor Web 3.0 would ever benefit from them. Simply put, a CBDC is a digital fiat. According to Kent Barton, tokenomics lead at ShapeShiftDAO, “it’s hard to see how these are actually substantially different from the money we have now” because the majority of currency transactions are already digital in form.