The Rise of Central Bank Digital Currencies (CBDCs): A Threat to Crypto?

The cryptocurrencies of the present, such as Bitcoin and Ethereum, have been all the rage lately since it has given new opportunities for transactions, investments, and storing value through decentralization. They have done this by promising freedom from the influence of traditional financial institutions, namely, banks. However, the situation is changing now that digital money will have another option: Central Bank Digital Currencies (CBDCs) are the new entrants to the scene. These are digital currencies that are government-backed and are issued and regulated by central banks among others, and they are quickly rising with some relevant issues like: Can CBDCs nullify the crypto universe? Conversely, can they jointly live in a way that both could reciprocally serve different purposes? In this blog, we shall look into the details of the CBDCs, the need for them by the governments, and how they would affect the cryptocurrency scene.

What is a Central Bank Digital Currency (CBDC)?

A Central Bank Digital Currency (CBDC) is an example of a digital version of the official currency of a country that is issued by its central bank. It’s different from the crypto coins like Bitcoin and Ethereum which use decentralized networks not worried with the authority of governments. CBDCs, however, are controlled by a single authority. This signifies that their value, the process of their distribution, and all the other regulating aspects are the responsibilities of the country’s leading authority. Central Bank Digital Currencies are guaranteed to work like regular money but in electronic form. To explain, The Digital Dollar will be like the U.S. Dollar, but the difference is in the form of the currency- Digital. It will be issued by the Federal Reserve. Other countries are also experimenting or building their CBDCs like China, the European Union, and Canada.

Key Features of CBDCs:

1. Government-issued: The single power of the issuance of the currency is the full guarantee to the central bank which is the sole official authority in the country.
2. Digital: The CBDCs are merely present in an electronic world that is far removed from the physical (coins and banknotes) reality of clones of physical currency.
3. Legal tender: They have been declared legal tender and hence are used for all commodities in the country and all categories of transactions.
4. Centralized control: CBDCs are under the supervision and regulation of the central bank, whereas, cryptocurrency, characterized by their decentralized nature, is not regulated by a single central authority.

Why are CBDCs Gaining Popularity?

CBDC’s favorization is attributed to several different reasons, among which are the issues connected with cryptocurrencies and the need for a modern digital financial ecosystem.

1. Combatting Cryptocurrencies and Stablecoins

The types of cryptocurrencies that have reached a substantial hype in the last several years have been successful in grabbing a big part of the traditional finance market. Some consider them as a banking alternative; however, as they are decentralized, they present themselves as a significant challenge for governments. The reality is that stablecoins, the digital assets also seem to make this problem worse as they are connected to the U.S. Dollar and many other currencies that skip the normal bank system of the central banks. Central bank digital currencies are an alternative controlled by the government that can compete with decentralized digital currencies and conventional financial markets. The central banks are still to retain control of their systems through these digital solutions, while the transactions are available in digital form. The government can comfortably dominate the private sector of digital currencies and remain the gear of the economic wheel by creating its currency.

2. Improved Payment Efficiency

Most of the time, the traditional payment systems, let alone the cross-border ones, are slow and costly. CBDCs when deployed will lead to a decrease in cross-border payment costs and become faster. On the other hand, central banks look at digital solutions to direct payment through the banking system, reduce the fees of transactions and time traders need to settle, and of course, the overall efficiency.

3. Financial Inclusion

Banks are still out of reach of a great number of people in the third world. The problem is that people bypass banks also, so the banks will get people up to date through mobile money rather than using it as an option. CBDCs in developing countries could easily come in as an option where there are parts that people cannot access through banks through financial inclusion. Using a smartphone that is available more than a bank in many places in the world, a CBDC might provide an inexpensive and accessible way for people to get involved in the finance sector.

4. Monetary Policy Control

CBDCs, if implemented by central banks, will provide them with a whole new instrument to boost the economy. As a reaction to technological advancement, central banks could shape monetary policy more precisely given that they could have access to actual figures of the flow of money and online transactions continually. Plus, in the face of a financial meltdown, central banks could bring to bear their digital money and infuse money directly into the hands of citizens or businesses bypassing traditional banking which would otherwise be slow and less efficient.

CBDCs vs. Cryptocurrencies: Key Differences

The terms “Central Bank Digital Currencies” or CBDCs and cryptocurrencies are sometimes used interchangeably, but they do not mean the same thing at all; in fact, they are completely different in the following aspects:

1. Centralization vs. Decentralization

Without a doubt, the most significant difference lies in which one is centralized. Cryptocurrencies such as Bitcoin and Ethereum are decentralized in that no single entity holds the ledger. To the best advantage of crypto supporters, who view the decentralized characteristics as a means of liberating themselves from government and bank manipulations, CBDCs nonetheless are fully under the control of the corresponding issuer, the central bank. This way, the government will be able to supervise and keep records of every transaction.

2. Privacy and Transparency

Cryptocurrencies, to begin with, offer a greater degree of privacy due to their transactions being pseudo-anonymous, which do not impose on the parties involved the need to reveal their data. These transactions are public knowledge as they are recorded on a blockchain, but the users’ wallet addresses have nothing to do with their identities. Bank-issued digital currencies are to the contrary expected to be substantially more transparent. Banks will have the ability to watch the transactions of every user, and this could bring about worries about surveillance and personal data privacy. To those who place importance on the ability to stay anonymous in their financial undertakings, the strengthening of CBDCs may seem as if the right to be anonymous has been taken away.

3. Monetary Policy Influence

Since they are outside the boundaries of any central authority, cryptocurrencies are not much affected by monetary policies, such as interest rate manipulations and inflation control. They are their separate entity, operating outside the sphere of any major central regulator. Therefore, they are invulnerable and irrationality-free. On the other hand, CBDCs are designed to complement the current monetary system. Thus, they would be the tools in the hands of central banks to more directly impact the state of the economy.

4. Legal Tender

Most of the countries do not accept digital currencies as legal tender. However, CBDCs are a digital currency by the government, which is officially recognized and supported by the state. It is a digital currency exchanged by the government for all legal reasons. Although common cryptocurrencies rarely sound like they are a bubble or a quick way to pay, the ones that they are not sure of or independent digital currencies that are similar to them still do not have any state support or the government’s liability for loss.

Will CBDCs Threaten Cryptocurrencies?

The issuance of digital money by the central banks of many nations prompts a search for a stone to cast at cryptocurrencies. Did they even have a threat to the future of the crypto industry?

1. Government Control

For crypto enthusiasts who love them for the freedom and neutrality of governance, CBDCs might appear as a yoke to the very idea of the state of blockchain. Coupled with this, the government could, as a result, snatch away the majority of the coins and exercise more control of the money supply, it could see everyone, every transaction, and even potentially restrain people’s spending use of their digital currencies. Governments through their digital systems can cut short the money supply available for the private sector to evade macroeconomic policies and control money laundering. Consequently, the government would establish a system that would include electronic money and the CBDCs within the realm of their power and the private sector. Contrarily, cryptocurrencies such as Bitcoin and Ethereum afford individuals economic independence, the torchbearers of which, besides, will be no one to freeze accounts or trail transactions. The introduction of CBDCs, while also decentralizing the money system in the country and enabling quick and convenient payments for people, might lead to people’s probable displeasure at the loss of privacy and ability to remain autonomous.

2. Stable Value vs. Volatility

Alternatively, digital currencies are something you can buy something with and can also be used to trade in the first of the kind are crypto ones, especially Bitcoins, which rely on a limited supply of 21 million (total coins). It is because of this natural deficiency that Bitcoin’s value has become attractive to some as a preservation of their assets even when inflation starts or any traditional market is at risk. At the same time, the government would base the value of their CDBC on the rate of their fiat currency. The problem with cryptocurrencies is that they are quite erratic so it is not very convenient to use them the whole day for prices would jump sky-high the next moment and then plummet right to the ground in the other when one just wants to get rid of them quickly. However, if one would have been careful to make good use of the stock of CBDCs the whole cause could be less and less of a transnational bias, hence the people working in other countries feeling the difference because they are finding the systems there are better than the hyperinflated currencies at home.

3. Innovation in Blockchain Technology

Instead of taking on cryptocurrencies face-to-face, the latter can become a mover of new thoughts and ideas in the blockchain and digital money sector. Commercial banks have previously commenced the utilization of sophisticated blockchain technology to back up CBDCs which in turn could bridge the gap between digital currencies and blockchain systems.

Stay informed and ready for the future of finance.

CBDCs are the things that make banks and governments modify their financial systems and control their economies perfectly. But these digital dollars can also present some serious security issues as well as possible issues of government control and the future of decentralized finance. CBDCs, even though they may be a challenge to cryptos due to the competition for daily use and monetary policy control, are quite unlikely to be the reason for them to go out of use. It’s decentralized, borderless, and the possibility to use it as a store of value that will most likely be still the winner of the popularity contest. CBDCs do not have to be looked at only as competitors to traditional currencies. Even so, the future of crypto will be kindled as central banks do not stop yes-or-no discussions of digital matters and, at the same time, the cryptocurrencies will be integrated into the decentralized Finance (DeFi) system with their applications. CBDCs are not a signal of the end of coins like crypto, rather this is just the first cut in the digital economy’s 2nd chapter.