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Bittime - Central Bank Digital Currency (CBDC) is a form of digital currency issued by a country's central bank. They are similar to cryptocurrencies, except their value is set by a central bank and is equivalent to the country's fiat currency.
Many countries are developing CBDCs, and some have even implemented them.
Since so many countries are researching ways to switch to digital currencies, it is important to understand what they are and what they mean for society
Also Read CBDC: New Digital Currency Plans in the Philippines
What is Central Bank Digital Currency (CBDC)?
Central Bank Digital Currency (CBDC) is a digital form of a country's fiat currency. A country's monetary authority, or central bank, issues a CBDC, which promotes financial inclusion and simplifies the implementation of monetary and fiscal policies.
Many countries are exploring how CBDCs might impact their economies, financial networks, and stability.
Also Read : Why Are Central Banks Interested in CBDC? This is the explanation!
Understanding Central Bank Digital Currency (CBDC)
Fiat money is currency issued by governments that is not backed by physical commodities such as gold or silver. It is considered a legal form of payment that can be used for the exchange of goods and services.
Traditionally, fiat money comes in the form of banknotes and coins, but technology has allowed governments and financial institutions to supplement physical fiat money with credit-based models that record balances and transactions digitally.
Physical currency is still widely exchanged and accepted; however, some developed countries have seen their use decline, and that trend accelerated during the pandemic.
Also Read eNaira: Nigeria's CBDC Pioneer and Its Impact on the Future of Finance
Purpose of Central Bank Digital Currency (CBDC)
In the US and many other countries, many individuals do not have access to financial services. In the US alone, 5% of adults did not have a bank account in 2020. The 13% of US adults who have a bank account instead use expensive alternative services such as money orders, payday loans, and check cashing services.
Tujuan utama CBDC adalah memberikan bisnis dan konsumen privasi, transferabilitas, kemudahan akses, dan keamanan keuangan. CBDC juga dapat mengurangi biaya perawatan yang dibutuhkan oleh sistem keuangan yang kompleks, mengurangi biaya transaksi lintas negara, dan memberikan opsi yang lebih murah kepada mereka yang saat ini menggunakan metode transfer uang alternatif.
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Projected to be More Stable
A CBDC would also reduce the risks associated with the use of digital currencies, or cryptocurrencies, in their current form. Cryptocurrencies are highly volatile, with values constantly fluctuating.
This volatility can cause severe financial stress in many households and affect overall economic stability. CBDCs, backed by governments and controlled by central banks, will provide households, consumers, and businesses with a secure means of exchanging digital currencies.
Also Read: CBDC Regulations in Asia-Pacific: Driving Digital Financial Innovation
Types of CBDC There are two types of CBDC, namely Wholesale and Retail
Financial institutions are the main users of wholesale CBDCs, while consumers and businesses use retail CBDCs.
Wholesale CBDC
Wholesale CBDC is similar to holding reserves at a central bank. Central banks provide institutions with accounts to deposit funds or use to settle interbank transfers.
The central bank can then use monetary policy tools, such as reserve requirements or interest on reserve balances, to influence lending and set interest rates.
Retail CBDC
Retail CBDC is a government-backed digital currency used by consumers and businesses. Retail CBDCs eliminate middleman risk – the risk that a private digital currency issuer might go bankrupt and lose customer assets.
There are two types of Retail CBDC
They differ in how individual users access and use their currency:
- Token-based Retail CBDCs can be accessed with private keys or public keys or both. This validation method allows users to carry out transactions anonymously.
- Account-based Retail CBDC requires digital identification to access the account.
Problems Solved and Created by CBDC
The Federal Reserve has identified critical requirements that a CBDC must meet, as well as issues that need to be addressed before it can be designed and implemented.
Problems Solved by CBDC explained
- Eliminates third party risk from events such as bank bankruptcy or mass withdrawals. Any residual risk remaining in the system rests with the central bank.
- Can reduce high cross-border transaction costs by reducing complex distribution systems and increasing jurisdictional cooperation between governments.
- Can support and protect US dollar dominance; The US dollar is still the most widely used currency in the world.
- Eliminating the costs of implementing financial structures within a country to bring financial access to the unbanked population.
- Can establish a direct link between consumers and central banks, eliminating the need for expensive infrastructure.
Problems Created by CBDC
- If the US financial structure changed drastically, it is unknown how it would affect household spending, investment, banking reserves, interest rates, the financial services sector, or the economy.
- The effect that switching to a CBDC will have on the stability of the financial system is also unknown. For example, there may not be enough central bank liquidity to facilitate withdrawals during a financial crisis.
- Central banks implement monetary policy to influence inflation, interest rates, borrowing, and spending, which in turn influence the level of employment. Central banks must ensure that they have the necessary tools to have a positive impact on the economy.
- Privacy is one of the biggest drivers behind cryptocurrencies. CBDC will require an appropriate amount of intervention by authorities to monitor financial crime; monitoring is also important because it supports efforts to combat money laundering and terrorism financing.
- Cryptocurrencies have become a target for hackers and thieves. Central bank-issued digital currencies will likely attract similar attention from thieves. Therefore, efforts to prevent system penetration and theft of assets and information must be strong.
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CBDC vs Cryptocurrency
The cryptocurrency ecosystem provides a glimpse of an alternative currency system where cumbersome regulations do not dictate the terms of each transaction. They are difficult to imitate or counterfeit and are secured by consensus mechanisms that prevent smuggling.
Additionally, cryptocurrencies are unregulated and decentralized. Their value is determined by investor sentiment, usage, and user interest.
They are highly volatile assets better suited to speculation, which makes them unlikely candidates for use in a financial system that requires stability.
CBDC reflects the value of fiat currency and is designed for stability and security.
A Brief Look at Central Bank Digital Currency
Central banks in many countries have pilot programs and research projects to determine the feasibility and usefulness of CBDCs in their economies. As of March 2023, there are 11 countries and territories with CBDCs.
They are the Bahamas, Antigua and Barbuda, St. St. Kitts and Nevis, Monserrat, Dominica, Santa Lucia, St. St. Vincent and the Grenadines, Grenada, and Nigeria. Eighteen countries now have pilot programs, including seven of the G20 economies, and 32 countries have programs in development.
According to the Federal Reserve, the US is one of the countries exploring whether a CBDC "could enhance the US's already secure and efficient domestic payments system."
Also Read FedNow: Instant Payment Revolution in the Digital Era
Is CBDC a Cryptocurrency?
Although the idea for the Central Bank Digital Currency comes from cryptocurrencies and blockchain technology, CBDC is not a cryptocurrency.
Central banks control CBDCs, while cryptocurrencies are almost always decentralized, meaning they cannot be regulated by a single authority, like banks.
Is CBDC Based on Blockchain?
A CBDC can be based on a blockchain, but it doesn't need to be. The Federal Reserve Bank of Boston and the Massachusetts Institute of Technology (MIT) Digital Currency Initiative found in their research that distributed ledgers can hinder the efficiency and scalability of CBDCs.
Closing
Many countries are developing a Central Bank Digital Currency (CBDC), and 11 have already implemented it. The main goal of CBDC is to provide businesses and consumers with privacy, transferability, convenience, accessibility and financial security. Many individuals around the world don't have access to a bank account, so a CBDC would give them a way to get paid, store their money, and pay bills.
CBDCs can also reduce the maintenance required by complex financial systems, reduce cross-border transaction costs, and provide a cheaper option for people using alternative money transfer methods.
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DISCLAIMER: This article is informational in nature and is not an offer or invitation to sell or buy any crypto assets. Trading crypto assets is a high-risk activity. Crypto asset prices are volatile, where prices can change significantly from time to time and Bittime is not responsible for changes in fluctuations in crypto asset exchange rates.
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