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What is a Central Bank Digital Currency (CBDC)?

CBDC is the digital version of fiduciary money (fiat currency) set as the legal tender by a government act or a currency regulator in a given jurisdiction. However, there’s a stark distinction between a Central Bank Digital Currency and cryptocurrency. Whereas the former is declared a medium of exchange by a centralized governing body, the latter uses a distributed ledger and is devoid of a governing body’s legal tender tag.

Moreover, it’s important to note that the concept of Central Bank Digital Currency (CBDC) currently exists as a hypothesis. However, with the spike in digitalization, the idea may find its place in the currency ecosystem.

Pioneers of Digital Cash

The Central Bank of England has already earned its place as a global pacesetter of digital currency. The regulatory bank plays host to deposits in the form of digital money from England’s commercial banks that run accounts with it.

Let’s imagine a scenario where the Central bank of England wants to issue digital currency to ordinary citizens and non-bank corporations. The situation could only find a solution in two ways.

First, the bank could decide on a direct approach where it opens and plays host to bank accounts for all the English citizens. Along with them would come the need for bank cards, online banking facilities, and such. However, the bank would feel that this would come with a heavy operational burden and better left to the private banking sector’s management.

On the other hand, the regulator bank can decide to use the indirect approach. In this approach, the bank would still play the digital currency issuer’s role, but delegate the customer support operations to the private banking sector. The private banks would hold the Digital Cash Accounts (DCA) for the citizens and come up with banking solutions like ATM cards, online banking facilities, payment services, and customer care services.

Governments exploring CBDC

Some governments and countries are already exploring and developing CBDC’s:

Benefits of CBDC

These would be the benefits of digital cash if rolled out by any central bank.

Efficiency in Payments

Payments using smartphone applications and debit cards may completely phase out cash payments due to the convenience aspect. Additionally, electronic currency change could soon phase out the challenges faced by retail outlets and traders in giving change, especially for the lower denominations.

Traceable and Secure

Digital currency doesn’t pose the security risk borne by physical cash when carrying it from one place to another. Unlike cash, digital money transactions leave traceable records of transactions. With proper records, disputes easily find a solution.

The Downside of Digital Currency

Digital transactions are easily traceable. Unlike cash users, digital currency users could lament infringed privacy in that a central governing body has records of their financial activities. The scrutiny may discourage them from using the digital currency.

Conclusion

Central banks buckle under growing pressure from currency users who keep deposits, spend and transfer money without even using fiat currency. Moreover, the convenience, timeliness, and low cost of cashless transactions emerge as the key drivers towards adopting a digital currency by the central banks.

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