CBDC Central Bank Digital Currency is simply digital fiat DFC Digital Fiat Currency, whereas cryptocurrencies are digital assets on a decentralized network.
CBDCs mirror the value of fiat currency and are designed for stability and safety.
- A central bank digital currency is the digital form of a country's fiat
- A CBDC is issued and regulated by a nations monetary authority or central bank.
- CBDCs promote financial inclusion and simplify the implementation of monetary and fiscal policy.
- Many countries are exploring how CBDCs will affect their economies, existing financial networks, and stability.
Fiat money is a government issued currency that is not backed by a physical commodity like gold or silver. It is considered a form of a legal tender, that can be used to exchange goods and services.
Physical currency is still widely exchanged and accepted.
Technology has allowed governments and financial institutions to supplement physical fiat money with a credit based model in which balances and transactions are recorded digitally.
The introduction and evolution of cryptocurrency and blockchain technology have created further interest in cashless societies and digital currencies.
Fiat money is a government issued currency that is not backed by a physical commodity like gold or silver. It is considered a form of a legal tender, that can be used to exchange goods and services.
Physical currency is still widely exchanged and accepted.
Technology has allowed governments and financial institutions to supplement physical fiat money with a credit based model in which balances and transactions are recorded digitally.
The introduction and evolution of cryptocurrency and blockchain technology have created further interest in cashless societies and digital currencies.
There are 2 types of CBDC’s:
It is possible to develop both and have them function in the same economy.
- Wholesale CBDCs are similar to holding reserves in a central bank. The central bank grants an institution an account to deposit funds or use to settle interbank transfers. Central banks can then use monetary policy tools such as reserve requirements or interest on reserve balances to influence lending and set interest rates.
- Retail CBDCs are government backed digital currencies used by consumers and businesses.
Token based retail CBDCs are accessible with private/public keys. This method of validation allows users to execute transactions anonymously.
Account-based retail CBDCs require digital identification to access an account.
Digital fiat is a major innovation in financial technology.
It overcomes the problems of cash and makes payment systems faster and cheaper. But it has the attendant problems of technology, as digital fiat can be hacked and can erode privacy.
Advantages of Digital Fiat:
- Digital fiat eliminates the need for physical storage and safekeeping that is a characteristic of cash-intensive systems. You do not need to invest in a wallet or bank vaults to ensure that your money is not stolen.
- Digital fiat simplifies accounting and record-keeping for transactions through technology. Therefore, manual accounting and separate entity-specific ledgers are not necessary to maintain records of transactions.
- While it has already shortened the amount of time and the cost required to transfer money across borders, digital fiat has the potential to further revolutionize the industry by eliminating intermediaries and further reducing the costs associated with cross-border transfers.
- Digital fiat removes intermediaries in the implementation of monetary policy and makes it possible to include groups of people who were previously excluded from the economy. For example, those who are unbanked can still participate in an economy by using digital fiat present in their online wallet or mobile phones.
- In the case of cryptocurrencies, digital fiat transactions can become censorship-resistant, meaning they can be impervious to tracking by government or other authorities.
Disadvantages of Digital Fiat:
- Digital fiat is susceptible to hacking. Even as it removes the need for physical safekeeping, digital fiat's origins in technology ensure that this form of money becomes a target for hackers, who can steal from digital wallets.
- A seamless financial infrastructure consisting of digitally connected entities can be brought down by hackers. Hacks of digital fiat on a large scale have the potential to bring a country's financial infrastructure to heel and become a national security threat.
- Digital fiat use can compromise user privacy. Cash is anonymous, and it is nearly impossible to track and trace its users. On the other hand, digital fiat can be traced. While the use of internet cookies enables targeted advertising, the implications for digital fiat tracking are more far reaching.
- Organizations or governments could blacklist or freeze accounts without the permission of users.
- Digital fiat presents several challenges on the governance and policy framework front.
The cryptocurrency ecosystems provide a glimpse of an alternate currency system in which cumbersome regulations do not dictate the terms of each transaction. They are hard to duplicate or counterfeit and are secured by consensus mechanisms that prevent tampering.
Central bank digital currencies are designed to be similar to cryptocurrencies, but they may not require blockchain technology or consensus mechanisms.
A decentralized CBDC can explore the advantages of digital technologies more deeply than the centralized ones by making reconciliations between central banks in real-time.
Digital fiat is a major innovation in financial technology.
It overcomes the problems of cash and makes payment systems faster and cheaper. But it has the attendant problems of technology, as digital fiat can be hacked and can erode privacy.
Taken together, careful design and policy considerations will underpin trust in CBDCs.
Trust must be anchored in credible central banks with a history of delivering on their mandates.
This is just the beginning of an exciting journey.
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