A country’s central bank issues a central bank digital currency (CBDC) as a digital asset class. It is the digital form of a country’s fiat currency. Digital CBDCs differ from other crypto assets because their value is often pegged to the country’s central bank, near the country’s local currency.
CBDCs are hot in various jurisdictions as they provide a clear path for countries looking to leverage the power of cryptocurrency. The digital asset class also serves as a viable conduit for traditional financial institutions like the central bank to launch a digital asset product while maintaining significant control over key aspects like price.
Various countries are experimenting with CBDCs, while some have already launched their own strain of digital assets.
- The Bahamas launched the Sand Dollar, Jamaica the JAM-DEX, and Nigeria the eNaira, all retail CBDCs aimed at domestic expansion.
- The BRICS countries (Brazil, Russia, India, China, and South Africa) are piloting CBDCs, with China notably advanced. This reflects geopolitical competition in digital currencies.
- In his farewell speech, Shaktikanta Das, the incoming governor of the Reserve Bank of India (RBI), revealed that India is close to becoming a CBDC-driven economy.
CBDCs, like other crypto assets, have challenges that might hinder their adoption, but now, the pros outweigh the cons.
The Federal Reserve explores CBDCs in the United States through projects like Project Agorá. Project Agora is a cross-border wholesale CBDC initiative with six major central banks. The project remains in its initiation stage, and decision-makers have not reached any significant conclusion at the time of this report.
CBDCs as a Digital Asset
At its core, a central bank digital currency is the digital form of a country’s fiat currency. Since the advent of technology, FIAT money has been perceived as a thing of the past, which has presented numerous challenges.
Technology ushered in the idea of a “Cashless Society”, with products like Digital Payment Platforms and Payment Cards driving adoption and slowly replacing physical cash.
CBDCs are an extension of this drive for a cashless society championed by a country’s Apex Financial institution. The end users categorize CBDCS into two primary types.
Wholesale CBDCs
Wholesale CBDCs are used mainly by financial institutions, not retail consumers. The digital asset class can also be used as a central bank’s reserve.
According to Investopedia, wholesale CBDC functions when the central bank grants an institution an account to deposit funds or settle interbank transfers. Central banks can then use monetary policy tools, such as reserve requirements or interest on reserve balances, to set interest rates and influence lending.
Retail CBDCs
Due to the number of their end users, retail CBDCs are the most commonly used CBDCs. They are government-backed digital currencies used by consumers and businesses.
Retail CBDCs are at the intersection of traditional finance and digital assets. Their main selling point is the security the central bank provides, which is non-existent with private issuers.
A good example is the eNaira, which President Muhammadu Buhari of Nigeria officially launched on October 25, 2021. This made Nigeria the first African country to introduce a CBDC.
Another example is the digital yuan issued by the PBOC, China’s central bank. It is pegged 1:1 to the physical yuan, making it a stable, government-backed digital currency, not a speculative asset like Bitcoin.
CBDCs vs Cryptocurrency
CBDCs are a strain of cryptocurrencies that differ from other crypto assets in a few areas. Despite being digital assets, the two asset classes differ in structure, price value, use case, and technology.
Structure
The entire idea of cryptocurrency, as envisioned by Satoshi Nakamoto, is decentralization. Cryptocurrency promises a global financial system away from the control of traditional institutions and geopolitical powers.
CBDCs remain a few steps away from this vision because a nation’s central bank controls and manages them. They represent a middle ground between the traditional financial system and the emerging world of blockchain-powered digital assets. Their centralized nature sets them apart from most other crypto assets, which typically operate in a decentralized manner.
Price Value
Price value is another key factor that differs between CBDCs and other crypto assets. Various factors, including market capitalization and the laws of supply and demand, determine the prices of crypto assets. However, CBDCs are pegged to the value of the nation’s fiat currency in a 1:1 ratio.
CBDCs have a slight advantage in terms of volatility due to their peg to a Fiat currency. The closest crypto assets to CBDCs are stablecoins, which have value pegged to a fiat currency, primarily the dollar.
Use Case
Central banks design CBDCs to serve as legal tender for everyday use, including payments, savings, and taxes. They mirror cash but are digital. They are designed to replace physical Fiat without displacing the country’s local currency.
Developers create other crypto assets as alternatives to fiat currency, like Bitcoin as “digital gold,” or as platforms for innovation, like Ethereum for smart contracts.
They’re typically investment vehicles, stores of value, or tech ecosystems, not legal tender like CBDCs.
Benefits of CBDC
CBDCs have many benefits, usually mitigating challenges created by physical cash and exceeding its limitations. Their digital nature means the asset class shares many benefits with other crypto assets, providing a viable upgrade to the Cash System.
Stability
CBDCs maintain relative stability compared to other crypto assets because the issuing country pegs their value to its fiat currency.This is an improvement from crypto assets like memecoins, which are highly volatile and make for risky investment vehicles.
However, CBDCs pegged to Fiat are not entirely immune to volatility. Any changes to the issuing nation’s fiat currency can directly affect the price value of a CBDC.
Transparency
CBDCs are digital assets, so every transaction leaves a traceable and easily recorded digital footprint. Regulators can use this advantage to curb illicit activities in the financial sector.
It also helps reduce cash-related crimes like robbery by promoting a cashless society with very little physical cash in circulation.
Conclusion
CBDCs are a melting point, bringing together the old traditional finance world and the new kid on the block. The product helped solve the Thucydides Trap problem in the global finance system.
Despite this, the concept is still in the initiation stage in various countries, and very few have successfully launched CBDCs. CBDCs face adoption challenges competing with widely accepted FIAT and cutting-edge cryptocurrencies for retail consumers. For example, Nigeria’s naira has struggled to gain adoption since its launch in 2021.
By October 2022, less than 0.5% of Nigerians used it, though wallet numbers jumped to 13 million by March 2023 after a cash shortage. Still, a 2023 IMF report noted that 98.5% of wallets remained inactive.
Other jurisdictions, such as the BRICS and the United States, are experimenting with their versions of CBDCs, which suggests a promising future for the asset class. The ongoing debate on this strain of digital assets surrounds its design and the ripple effect on geopolitics, given the role of currency in determining geopolitical dynamics.
