Central Bank Digital Currencies (CBDC): What They Are and How They Work

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Following the success of decentralized digital currencies such as bitcoin and the development of fiat currency-backed stablecoin, central banks across the globe have started to research and trial so-called central bank digital currencies (CBDCs).

In this guide, you will discover what central bank digital currencies are and what they may look like in the future.

What Are Central Bank Digital Currencies (CBDCs)?

In a recent report, the Bank of International Settlements defined central bank digital currencies as “a new form of central bank money that is […] denominated in an existing unit of account, which serves both as a medium of exchange and a store of value.”

A central bank digital currency (CBDC) could also be described as electronic money powered by distributed ledger technology that would enable central banks to issue their sovereign currency on the blockchain.

Benefits of a CBDC may include:

  • New payment systems
  • Improved monetary policy transmission
  • Enhanced settlement efficiency for securities and derivatives

A number of countries are actively exploring central bank digital currencies (CBDCs), including Canada, Iran, the Netherlands, Singapore, South Africa, and Sweden, among others.

Wholesale Versus General Purpose CBDCs

Currently, the two main types of central bank digital currencies that are being explored are wholesale and general purpose CBDCs.

Wholesale CBDCs would be central bank-issued digital money used by the central bank to transact with banks and are other members of the institutional financial market.

General purpose CBDCs would be central bank-issued e-money that would be used by everyone from financial institutions to the general public.

While both of these versions of CBDCs are being explored, we are more likely to see wholesale CBDCs first as general purpose CBDCs could lead to the disintermediation of banks. Therefore, it is unlikely that a central bank would want to see a push for that much disruption given that the stability of a country’s financial system is high on the agenda of central banks.

How Would a CBDC Work?

A central bank digital currency would be a blockchain-based digital token that runs on a permissible blockchain owned and operated by the central bank and (likely also) maintained by a number of commercial stakeholders with the country’s financial industry.

Transactions would be private and not publicly viewable to comply with financial secrecy laws and regulations. However, the central bank, as the key owner of the blockchain, would be able to view and track every single financial transaction that takes place in its issued e-currency.

The management of the e-currency’s money supply would be controlled by the central bank, giving it potentially unprecedented control and transparency over a country’s financial system.

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While it remains to be seen what will happen as central banks experiment with CBDCs, it is safe to say that developments in this space will be of interest to blockchain investors globally. To stay up-to-date with the most important trends in digital asset investing, subscribe to the Bitcoin Market Journal newsletter today.

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