What to Know About Central Bank Digital Currencies– CBDCs
Technological innovations have brought great change to traditional approaches to financial activities. Central banks aren’t left out of this quorum as they are prompted to research digital payment gateways and systems as a solution to the surprising decline in the use of cash in recent years, hence leading to the introduction of Central Bank Digital Currencies (CBDCs). And this emergence of CBDCs, in this age of blockchain technology and cryptocurrencies, helps to combat those companies that leverage these modern technologies to develop new payments.
Understanding Central Bank Digital Currency (CBCD)
To understand CBDC, you must first come to terms with the meaning of fiat money. Fiat money refers to a currency created by the government and isn’t backed up by any tangible commodity such as gold or silver. Regarded as a legal tender, and oftentimes minted as notes and coins, it can be used to exchange goods and services.
Technological advancements, however, have prompted both governments and financial institutions to recreate physical fiat money with a credit-based model which allows the digital recording of balances and transactions. This is not to say that physical cash isn’t still recognized and distributed, but its use has significantly declined in most high-income countries since the COVID-19 pandemic which indirectly showed the public how limited physical cash can be.
The cosmic rise of blockchain technologies and cryptocurrencies has led to a heightened interest in digital payment methodologies, thereby prompting governments and central banks all over the world to swerve towards using government-backed digital currencies. Upon adoption, these government-backed digital currencies act like fiat money with the cumulative trust and support of government and legal systems issuing.
Those digital currencies backed up by the government and administered by central banks are known as CBDCs. Its main purpose is to eliminate the potential risk in the maintenance of conventional financial systems which are often complex, inaccessible, inconvenient, and probably insecure; reduce cross-border transaction costs; and lower transaction costs for those who utilize other payment systems.
Above all, CBDCs aim to reduce the dangers associated with using digital currencies at the moment. Cryptocurrencies, for example, are quite volatile, so their price values are continually changing; this is a bed of thorns for most people, leading to financial meltdown and overall economic destabilization. While, on the other hand, CBDCs provide a good alternative to exchanging digital monies without having to worry about those incongruities.
CBDCs are primarily of two types: wholesale and retail. Whereas wholesale CBDCs are used by large financial institutions, retail CBDCs, which often act as physical forms of cash, are used by consumers and businesses. And both can be inculcated into the same economy.
Pros and Cons of Central Bank Digital Currencies
CBDCs are solution tendencies for traditional banks to compete with digital monetary policies. New leading innovations by Big Tech giants like Facebook and Amazon all agree on the progressiveness of CBDCs. In that accord, we will be delving into the popular advantages and disadvantages of central bank digital currencies to further your knowledge on the subject.
• One major positive impact of CBDC hinges on fostering lower transaction costs and providing faster and more reliable retail payments. This encourages, in one way or another, an economic boom alongside digital innovations.
• The cost price is lower in CBDCs because there’s a significant decrease in the cost of storage, production, and transport systems. Therefore, CBDCs can serve as cost-efficient alternatives for people who store cash for value.
• Traditionally, digital currencies can sustain their system through liquidity. Users can gain liquidity support, either short-term or long-term, without glitches, by using CBDCs, and this tendency can lead to financial inclusion and increase competition among banks or payment gateways.
• Another important feature of CBDCs is their elimination of intermediaries. Consequently, CBDCs can improve transaction speed and offer support for real-time payment tools.
• Central bank digital currencies also encourage anonymity during transactions. This breeds privacy in comparison to the conventional bank card payment system.
Having considered the pros of central bank digital currency, it’s of utmost importance that you understand its notable disadvantages.
• A major negative aspect of CBDCs is their geographic restrictions since they are accepted only in the country where they are being issued.
• CBDCs can force banks to lose income since central banks might become a better alternative use case than payment service providers, which reduces consumers’ demands for them.
• Most crypto-based CBDCs are highly prone to price volatility as they have no linkage to fiat currency. Central bank digital currencies increase the risks of a financial crisis.
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