Digital currencies have emerged as a significant financial phenomenon, and it is no longer a secret that they are here to stay. After initial skepticism and efforts to suppress their growth, the monetary authorities of many countries have started embracing the digital currency revolution. In this context, Central Bank Digital Currencies (CBDCs) are playing a critical role in shaping the future of money.

Author: Ana Nives Radovic
Publication: Fintechlopedia 2021
Presented in association with Visa Inc.

CBDCs are a digital form of fiat money issued by central banks, and they are designed to conduct government monetary policy and control the money supply in the country. Essentially, CBDCs are a currency established in the same way as traditional fiat currencies, through government decree, law, or monetary authority.

Only a few years ago, digital money was considered entirely outside of any regulatory framework, and there was no legal definition of any element of digital assets. Central financial institutions did not have a clear answer on how to regulate their flows. However, as digital money grew in popularity and became a necessity for a growing number of entities, central banks decided to step in and create specific digital assets.

CBDCs offer several advantages over traditional currencies. For one, they are more secure and can provide a higher level of financial privacy. Transactions conducted using CBDCs are traceable and can be audited, making them less susceptible to fraud and corruption. Additionally, CBDCs can reduce transaction costs and enhance financial inclusion, particularly for those who are unbanked or underbanked.

Moreover, CBDCs can help central banks to stabilize the economy and control inflation by regulating the money supply. They can also enhance cross-border transactions, reducing the need for intermediaries and lowering costs.

Many countries are already exploring the potential of CBDCs. For instance, the People’s Bank of China has been working on a digital version of the yuan for several years, and other countries like Sweden, Uruguay, and the Bahamas have already launched their own CBDCs. The European Central Bank has also announced its plans to launch a digital euro in the near future.

In conclusion, CBDCs represent the future of money. They offer several advantages over traditional currencies, and their potential is being recognized by an increasing number of countries. As the digital currency revolution continues to evolve, CBDCs will undoubtedly play a critical role in shaping the financial landscape of tomorrow.

A response to a growing trend

As interest in digital currencies continues to grow, many companies and institutions around the world have been moving away from physical money. In recent years, billions of euros worth of institutional and corporate funds have been allocated to cryptocurrencies, which have become a recognized form of assets with significant importance and influence.

The current global environment is saturated with payment service providers that offer centralized control, which has led many to seek alternative solutions that often operate outside the traditional banking system. Cryptocurrencies offer an attractive option as they are exchanged directly between the payer and the payee, without the need for a bank intermediary, and with the support of blockchain technology.

Recognizing this trend, central banks have responded by exploring the idea of issuing their own fully digitalized currencies. This move 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, initially saw cryptocurrencies as a threat to financial stability since they couldn’t have insight into the amount of funds circulating. However, they have responded to this challenge by issuing their own digital currencies, where cryptography is centralized. This key difference from cryptocurrencies ensures that the central bank has control over the money supply and can monitor and regulate the circulation of funds.

CBDCs offer several advantages over cryptocurrencies, including more stable value, lower transaction costs, and increased security. CBDCs can help central banks regulate the money supply, control inflation, and stabilize the economy. Additionally, CBDCs can enhance financial inclusion by providing access to digital payments for those who are unbanked or underbanked.

Several countries have already started exploring the potential of CBDCs, and some have already launched their own digital currencies. For instance, China’s digital yuan is already in circulation, and the European Central Bank has announced its plans to launch a digital euro. Other countries, such as Sweden, Uruguay, and the Bahamas, have also launched their own CBDCs.

In conclusion, the emergence of cryptocurrencies has disrupted traditional financial systems, and central banks have responded by exploring the potential of CBDCs. CBDCs offer several advantages over cryptocurrencies and traditional fiat currencies and can play a significant role in shaping the future of money. As more countries embrace CBDCs, we can expect to see a shift towards digital payments, which will have far-reaching implications for the global economy.

Basic characteristics of CBDC

The issuance of CBDCs has become a popular topic of discussion in recent years. CBDCs can take different forms and have varying characteristics, depending on their purpose. They can be seen as a representation of physical money, banknotes, and electronic deposits, or even as a new form of legal tender.

Central banks have the ability to issue CBDCs directly to commercial banks, payment service providers, and even individuals. These digital currencies can be exchanged in accordance with other monetary obligations of the central bank.

CBDCs are essentially electronically stored monetary value, which can take the form of a digital token or stored digitally. They serve the same functions as traditional currency, which includes being a means of payment, a store of value, and a unit of account. The difference, however, is that they are an advanced, sophisticated form of digital property that is issued on blockchain technology and remains centralized under the control of the government.

The purpose for which CBDCs are issued also differs, resulting in different types of CBDCs. Retail CBDCs, for example, are intended for the general public and are made available alongside physical currency. Interbank CBDCs, on the other hand, are only available to banks and are used for the settlement and delivery of financial assets.

CBDCs offer a new alternative to traditional payment systems, which have become saturated with intermediaries and centralized control. As such, CBDCs have been seen as a means of maintaining control over payment operations, even as the use of physical money declines. Central banks, recognizing the potential threat to financial stability that decentralized cryptocurrencies pose, have responded to this challenge by issuing their own digital currencies.

Improving the quality of payment services

The issuance of BDCs has the potential to improve the quality of payment services in various ways. CBDCs can lead to a reduction in intermediation costs, simplify cross-border payments, and contribute to the development of a cashless society. Additionally, CBDCs can aid in the fight against money laundering and corruption, as well as promote financial inclusion.

The specific benefits of CBDCs vary depending on the level of development of the country whose central bank issues them. In developed countries, CBDCs can be used as an alternative to cash and a means of reducing costs. In contrast, developing countries often see CBDCs as a way to make financial services more accessible to citizens.

Central banks have the ability to create CBDCs for all economic entities, which would essentially provide a digital means of payment that represents a claim from the central bank. Unlike cryptocurrencies, which are known for their volatility, the value of CBDCs is equivalent to that of the physical currency issued by the central bank.

Because the issuance of CBDCs is not seen as a reprinting of money that could lead to inflation, the process can help strengthen confidence in the currency, which is important for its value in transactions and seigniorage.

By bringing innovations to monetary systems and financial infrastructure, CBDCs can make payment services faster, cheaper, more efficient, and safer, making them more competitive. Ultimately, the main goal of CBDCs is to improve the quality of payment services and contribute to the economic development of the country.

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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.