What is CBDC?
Central Bank Digital Currencies Explained In Simple Terms
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TL;DR
So, Bitcoin is fantastic, right? But why can't I use it to pay my taxes or purchase coffee? While Bitcoin is a type of digital currency, utilising it as a daily currency may not be the best option. Another sort of digital asset, central bank digital currencies, will most likely be used for this purpose (CBDC).
The majority of countries are simply considering the concept of a totally digital currency, while some are actually putting it into practise. But what distinguishes CBDCs from other digital assets? Let's have a look.
Introduction
Traditional finance's technology for moving money around hasn't kept up with the rate of development in the rest of the globe. While transmitting money is merely a little more than moving bits from one location to another, it may be costly and time-consuming.
A new sort of digital money is being actively developed by several nations. The key advantages would be increased payment system efficiency and cheaper costs for all parties involved. CBDCs may be thought of as digital fiat money based on a new technology layer influenced by blockchain breakthroughs.
Many countries are anticipated to embrace digital currencies within the next decade. So, how do they function?
What is a central bank digital currency (CBDC)?
A central bank digital currency (CBDC) is a digital version of fiat currency issued by a central bank. As a result, government regulation has designated it as money.
The procedure to creating a CBDC will most likely differ greatly depending on the issuing nation. Some implementations will very certainly be based on blockchain or another sort of distributed ledger technology (DLT), while others will almost certainly be a centralised database. To symbolise the digital version of fiat currency, the blockchain-based ones will employ a token.
While it's possible that CBDCs were inspired by cryptocurrencies like Bitcoin, they're not the same. A government declares CBDCs legal money after a state issues them.
Cryptocurrencies like Bitcoin are decentralized and not issued by any government or governmental agency. Of course, this isn't to suggest that you won't be able to send money over national boundaries using a CBDC, but Bitcoin has no concept of national borders.
Many central banks are considering, if not actively pursuing, a CBDC proof-of-concept.
Since 2014, China has been working on a project known as DC/EP, which stands for Digital Currency/Electronic Payments. A pilot program for the digital yuan has already begun in many locations. In October 2020, the European Central Bank (ECB) published a paper proposing a digital euro and evaluating the benefits of such a digital currency.
Understanding central bank digital currencies (CBDC)
A CBDC is essentially a government-run and controlled database from a technology aspect (or possibly approved entities in the private sector). Only allowed actors have the capacity to transact on the network, which is why a CBDC is a permissioned database.
As a result, the centralized body in charge of the database has the power to block transactions, reversal transactions, "freeze" cash, and blacklist addresses.
Many CBDCs are likely to have their own blockchains. Some of them, however, might be issued on public blockchains. Permissioned assets would be placed on top of a permissionless base layer in this manner. This might provide central banks the best of both worlds, with the permissioned layer providing the requisite control and the permissionless layer providing the highest security assurances.
This, however, seems unlikely to be the case. No public blockchain currently has the technological capabilities or has endured the test of time long enough to properly execute such a critical task.
Aside from that, it's difficult to generalize how a CBDC operates because each country will take a different approach. They'll almost certainly customize the technology to meet their own requirements.
Benefits of central bank digital currencies (CBDCs)
You've probably heard the expression "banking the unbanked" in reference to cryptocurrency. While the concept is appealing, CBDCs are more likely to achieve this aim than decentralized cryptocurrencies such as Bitcoin. Financial inclusion may be increased if each legal citizen has simple access to a low-cost bank account.
Another advantage is the potential for technical breakthroughs as a result of changing the money system. While a large percentage of fiat money is made up of numbers in a database, the infrastructure is largely obsolete. On a Sunday afternoon, sending an email takes a few seconds, like it should. However, due to the existing banking system's intricacies, transmitting money can take many days.
We've seen that central banks must respond quicker than ever before in response to the COVID outbreak. CBDCs might make it easier for central banks and financial firms to enact monetary policy adjustments than ever before. This has the potential to change the way central banks operate.
Governments and central banks can trace illegal activities more easily with a CBDC.
CBDCs vs stablecoins
So, all of this sounds suspiciously like a stablecoin, doesn't it? They function similarly in that they both represent fiat money in the form of a digital token. They are, however, very different beneath the hood.
Stablecoins are essentially a representation of fiat money or another asset, and they're usually issued by a private business. They aren't fiat money, but they may be redeemed for the value they represent. CBDCs, on the other hand, are fiat money issued by the government.
CBDCs vs cryptocurrencies
CBDCs are not the same as cryptocurrencies, as we have said. CBDCs are issued by a central bank and accepted by the government as lawful money. A CBDC is a unit of account, a mode of payment, and a store of value, similar to banknotes.
Bitcoin and other true cryptocurrencies are pretty different. They are not issued by a government and are unconcerned with national boundaries. They are censorship-resistant, permissionless, and trustless. Furthermore, the network is not controlled by a single company. No one can prevent you from submitting a transaction to another Bitcoin address by blacklisting your Bitcoin address.
So, which is the superior option? It is dependent on the application. The capacity for Adil to transmit Bitcoin to Bob without the use of a middleman or the ability to censor the transaction is a significant concept. It does, however, have certain disadvantages. What if a large sum of money is taken? What if Adil delivers his life money to the wrong address by mistake?
It can be helpful for an entity to be able to reverse transactions or ban addresses on occasion. At other times, it's more practical to take use of the advantages that a decentralized network like Bitcoin may provide to the globe.
Last thoughts:
In a nutshell, central bank digital currencies are digital versions of fiat money. Many CBDC implementations will most likely make use of blockchain technology, making it easier for anybody to make digital payments.
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