What is CBDC (Central Bank Digital Currency)? Things You Need to Know - Central Bank Digital Currencies are a form of digital currency issued by a country's central bank.

    Before the COVID-19 pandemic, people still preferred to use cash to make physical transactions. Ever since the coronavirus struck, it has changed people’s shopping habits, driving a large increase in digital payments and online payment platforms via banks. This habit has continued to this day but a series of lawsuits, Luna collapse, bank failures, and negative crypto news recently has shaken investor confidence. That’s when the community’s attention turned to a group of digital currencies that are issued by central banks and reasonably controlled by a government-level organization.

    The Hong Kong government on June 1 will officially allow retail trading of cryptocurrencies, stepping up efforts to become a global hub for digital assets. They also decided to lift the ban on cryptocurrency trading, and unveiled its central bank digital currency (CBDC) pilot program for the e-HKD. So, what is CBDC?

    What is CBDC?

    CBDC (Central Bank Digital Currency) is a form of digital currency issued by a country’s central bank. It aims to support financial services for a nation’s government and its commercial-banking system, set monetary policy, and issue currency.  Being backed by a government and controlled by a central bank instead of a community is a huge difference between CBDCs and normal stablecoins.

    How CBDC work

    CBDCs work in a similar way to regular fiat currencies. It is like a digital payment system that allows users to instantly send and receive money anywhere. CBDC is not only a means of payment but also a store of value. Transactions on account-based CBDCs require verification IDs of the sender and receiver to complete transactions.

    Features of CBDC

    CBDC is issued and managed directly by the central bank so it aims to support financial services for a nation’s government and its commercial-banking system, set monetary policy, and issue currency. It can be seen that the value of CBDC will be affected by the domestic financial and economic situation.

    Central Bank Digital Currency is not a stablecoin. CBDCs share many similarities but are not known as a stablecoin. A stablecoin is a specific stable, private cryptocurrency pegged to a separate digital currency with the goal of maintaining a stable value over time. For example, Tether’s USDT or Circle’s USDC, which are both private companies,  issue digital currencies that are pegged to USD and must try to keep the token price close to the native token price, but it is not USD.

    Unlike decentralized cryptocurrencies, CBDCs are government-issued and operated. Their value is also the value of physical currency, and is equally affected and governed. CBDCs can be minted to control inflation like a regular national currency.

    One of the most prominent CBDCs is e-HKD, a digital currency of the Hong Kong government that is expected to launch in early June. On Twitter, Ripple also announced the company selected to present the CBDC use case for the e-HKD Pilot Program started at Fubon bank.

    In China, e-CNY has been introduced to the international community through the Olympic Games in Beijing in 2022. According to McKinsey, a company specializing in providing strategic research for many multinational corporations or government agencies, there are 87 countries, of which 90% of global GDP are in the process  of researching, developing, or already own CDBC.

    Advantages of CBDC

    Reduce costs: Unlike bank accounts that often require an annual maintenance fee, now with just a phone, all transactions can be completed.

    Reduce the risks associated with using digital currencies, or cryptocurrencies: Cryptocurrencies are highly volatile, with their value constantly fluctuating. This volatility could cause severe financial stress in many households and affect the overall stability of an economy. CBDCs, backed by a government and controlled by a central bank, would give households, consumers, and businesses a secure means of exchanging digital currency.

    Backed by government: Investors no longer have to worry about suffering heavy losses from the collapse of Terra or the FTX exchange.

    Market access: CBDCs allow investors easy to top up cryptocurrencies through the banking system, thereby overcoming market entry barriers.

    Increase transaction speed: CBDCs could improve the speed and efficiency of many countries’ electronic payment systems. 

    Disadvantages of CBDC

    When money becomes digital, it also becomes traceable and therefore taxable. This can become a hurdle to voluntary adoption. Another issue is a lack, so far, of technological stability. In January 2022, the digital version of Eastern Caribbean DCash went offline for two months because of technological issues.

    In addition, CBDCs may not confer the increased speed as predicted: many developed countries now activate instant payments using legacy (non-blockchain) infrastructure. Central banks in some nations, such as Canada and Singapore, have come to the conclusion that there isn’t currently a strong case for digital currency.

    Because CBDC is controlled by the government, it is completely centralized and controlled by the government in terms of cash flow. At the same time, their value is also completely dependent on the value of the local currency and the economy. Once the economy turns bad, CBDCs are in jeopardy, while Bitcoin, gold, and stablecoins are considered very good havens.

    Future of CBDC

    87 countries are in the process of developing their own CBDCs, showing its rapid growth. With a lot of advantages, this digital asset opens up countless opportunities for investors to easily access payment methods, so exposure to the crypto market is also simplified.

    However, the centralized nature of CBDCs is a danger to any economy or retail investor, once monetary policy or the national economy is not effectively controlled. Perhaps it still needs more time to show its superiority is really effective or not.

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