Regulated digital currencies replace physical currencies and facilitate transactions

The world is moving towards the digitalization of monetary transactions. In recent years, technologies such as blockchain and cryptocurrency have gained popularity among the public. On the other hand, banks are increasingly advocating the abandonment of paper money in favor of technological means of payment, facilitating online shopping, etc., and providing greater security to customers.

Against this backdrop, CBDC or central bank digital currency came into being.

“Central Bank Digital Currency (CBDC) is a digital form of money issued and backed by a country’s central bank. Unlike physical cash or traditional bank deposits, a CBDC is a digital representation of a national currency and is designed to co-exist with physical currency and existing electronic forms of money,” said engineer Marco Antonio Chambi Tambo, professor of systems engineering at Unifranz Franz Tamayo University.

Experts say this type of digital currency is backed by central banks and can save on transaction costs because they do not require conversion (have the same value as the currency they represent) and have no transfer costs (because they are managed in digital wallets).

Likewise, they distinguish between currencies intended for the general public (retail CBDC) and for high-value transactions (wholesale CBDC), providing different characteristics for each.

According to Chambi, unlike cryptocurrencies, which are regulated and backed by central banks, these currencies are decentralized and managed through blockchain technology, which provides transparency in their operations but also anonymity and lack of regulation, so they are only supported by supply and demand.

“Both CBDCs and cryptocurrencies are forms of digital money, but they differ significantly in terms of issuance, regulation, design, and objectives,” Chambi added.

Some of the differences between the two forms of digital currency are as follows:

Cryptocurrencies use blockchain (blockchain-based technology that contains encoded information about transactions on the network. And, they are intertwined, allowing the transfer of data through secure coding) without permission (public), while CBDCs use permissioned (private) blockchain.

“Anyone can read, write, and audit ongoing operations on a public blockchain network, which helps public blockchains maintain their self-governing nature. On the other hand, a private blockchain is a distributed ledger that functions as a closed and secure database based on the concepts of cryptography and is not decentralized,” Chambi said.

The limits on CBDC networks are set by the central bank. In a cryptocurrency network, power is distributed among the user base, which makes decisions by reaching consensus, the system engineer added.

Another difference is that CBDC can only be used as a means of payment, with a complete ban on accumulation or investment. In contrast, cryptocurrencies can be used for financial transactions and speculative purposes.

Experts say using CBDC has multiple advantages, such as reducing domestic and international transaction costs and time and improving the efficiency of payment systems.

On the other hand, they provide the convenience of financial services to people without bank accounts, providing a safe and simple way to use digital currency. In addition, transactions with CBDC can be more transparent and traceable, which helps combat money laundering and terrorist financing.

Chambi added: “CBDCs could also enable more efficient implementation of monetary policy as the central bank could directly control the supply of digital currency, promote innovation in the financial sector, and could increase the competitiveness of the banking system.”

Which countries have CBDCs?

Prior to COVID-19, central bank digital currencies were largely theoretical exercises. However, with the need to disperse massive monetary and fiscal stimulus measures around the world, and the rise of cryptocurrencies, central banks quickly realized they could not miss out on the evolution of money.

China topped the list, allowing foreign visitors to provide passport information to the People’s Bank of China using the digital yuan at the upcoming Winter Olympics. The Fed lagged far behind other major central banks, the European Central Bank, the Bank of Japan and the Bank of England.

Digital currencies have been fully launched in five countries. The first widely used CBDC is the Bahamian Sand Dollar. Fourteen countries, including large economies such as Sweden and South Korea, are currently testing (i.e. in the pilot phase) CBDCs for a formal launch.