CBDC or If You Can’t Beat Them – Join Them

They appeared as a financial phenomenon when it became clear to even the most suspicious that digital money is not a “bubble”, but one whose time is yet to come. Instead of the initial struggle to suppress this phenomenon, the monetary authorities of an increasing number of countries have accepted this challenge.

Central bank digital currencies are a digital form of fiat money issued by central banks. They conduct government monetary policy and control the money supply in the country, which means that it is a currency established in the same way as in the official case by government decree, law or monetary authority.

Only a few years earlier, digital money was entirely out of line with any regulatory framework, there was no legal definition of any element of digital assets, and central financial institutions did not yet have a single answer on how to regulate its flows.

However, as digital money was not only a passing trend, but a growing need and subject of interest of a growing number of entities, central banks decided to step into this realm themselves by creating specific digital assets.

A response to a growing trend

Many companies and institutions around the world began to move away from physical money when interest in digital currencies began to grow, after which billions of euros worth of institutional and corporate funds have been allocated in cryptocurrencies in recent years. Over time, cryptocurrencies became a recognized form of assets, and their importance and influence grew.

Also, the global environment has become saturated with payment service providers, control and centralization, which is why they sought alternative solutions that were often off the radar of the monetary authorities, because they included assets that are not in bank accounts.

Unlike a currency that is transferred from one bank account to another so that the bank is involved in the process, cryptocurrencies are exchanged directly between the payer and the payee, without a bank intermediary, and with the support of blockchain technology.

Therefore, the idea of central banks issuing fully digitalized currencies is part of the logic of abandoning cash and fiat money, based on the aspiration to maintain control over payment operations.

Central banks, which are responsible for conducting national monetary policy, recognized this as a threat to financial stability, as they could no longer have insight into the amount of funds circulating.

However, in the spirit of the time required to trade electronic assets, central banks have responded to this challenge by issuing their own digital money, where the issue of cryptography is centralized, which is the key difference from cryptocurrencies.

Basic characteristics of CBDC

The CBDC can take many forms with different characteristics, depending on the purpose, and can be viewed either as a symbolic depiction of money in its physical form, or banknotes and electronic deposits or as a new form of the depiction of legal tender.

Central banks can issue CBDCs directly to commercial banks and other payment service providers, and even to individuals, and their exchange takes place in accordance with other monetary obligations of the central bank.

The CBDC is an electronically stored monetary value – digitally or as a token, and has the same functions as a traditional currency – it is a means of payment, a custodian of value, and a unit of account. It, as an advanced, sophisticated form of digital property, is issued on blockchain technology and is in digital wallets, but remains centralized, i.e. under the control of the government by whose decision it is issued.

CBDCs differ from each other based on the purpose for which they were issued. There are CBDCs for retail, which are intended for the general public and placed on the market in parallel with the physical currency, and there are also interbank CBDCs, which are available only to banks for the purposes of settlement and delivery of financial assets.

Improving the quality of payment services

In particular, CBDCs enable the reduction of intermediation costs, simplify cross-border payments, contribute to the development of a cashless society, the fight against money laundering and corruption, as well as the development of financial inclusion.

Depending on the level of development of the country whose central bank issues the CBDC, the most noticeable division is developed countries that use the CBDC as an alternative to cash and the opportunity to reduce costs, while developing countries seek to make financial services more accessible to citizens.

Central banks have the possibility to create a CBDC for all economic entities, i.e. they could provide a digital means of payment, which would essentially be a claim from the central bank.

Unlike cryptocurrencies, which are characterized by sudden changes in value, the value of CBDC is equal to that of the physical currency of the central bank that issues them.

That is why the CBDC issuance process is not treated as a reprint of money that would have an inflationary effect and impact on the depreciation of the exchange rate, but to strengthen confidence in the currency, important for its value in transactions and seigniorage.

Thanks to that, the main task of the CBDC would be to bring innovations in the monetary systems and financial infrastructure that play an important role in the economic development of the country. Also, CBDC should make payment services faster, cheaper, more efficient, safer, and thus more competitive.

* * * * *

This content was brought to you by VISA, the global leader in digital payments, whose mission is to connect the world with an innovative and secure payment network to enable individuals, businesses, and economies to grow.

Visa is the general partner of the Fintechlopedia project, an electronic glossary containing all relevant elements of digital transactions and related phenomena, situations, processes, and innovations.