In the wake of a global pandemic, much of the world’s transactions have become digital. An attempt is being made in this direction for government-issued fiat, in the form of central bank digital currency. This, however, is distinct from a cryptocurrency like say Bitcoin.
One of the most basic differences between the two being that of government issuance. If you were to, for instance, buy cryptocurrencies in India, it would not be through a government authority. Central bank digital currency on the other hand, is the official government-issued fiat in a digital format.
Both entities, though operating in a digital form, differ in their fundamental characteristics. To gain a better understanding of their nuanced differences, give this post a read!
What exactly is central bank digital currency?
Central bank digital currency or CBDC is a central authority issued fiat which is present in a digital form. It is regulated by government institutions, and performs functions similar to that of cash, coins etc. And much like these, it is also backed by suitable reserves. Its introduction provides users with another avenue of conducting transactions. It also comes along with the added security of government regulations.
CBDCs aim at increasing access for digital currencies in general. They would also reduce the cost of transactions to an extent for users.
While no country has concretely launched any central bank digital currency yet, its introduction is being contemplated worldwide. The wider monetary and policy repercussions of it are being discussed at large.
Cryptocurrencies vs. Central bank digital currency
The former, like Bitcoin for instance, operate in a more fluid and decentralized manner. Cryptocurrencies ‘democratize’’ the global monetary systems. If you have to buy Bitcoin, you would not go through centralized regulations that govern CBDCs. Their only commonality is the fact that both cryptocurrencies and CBDC’s operate through a digital medium.
Cryptocurrencies provide a higher level of privacy for its users. Meaning, if you buy cryptocurrencies in India, it would not go through central banking channels, which in turn gives higher privacy to the transactions.
There are also a larger number of options available within cryptocurrency for users. It provides a high level of fluidity as the third party is eliminated in the process of conducting transactions for users. This also enables more peer-to-peer transactions to be facilitated.
CBDCs on the other hand continue to operate in the manner that fiat currency does. There remains a third party through which transactions materialize – this is often the central bank or government institutions.
Assessing the pros and cons of CBDCs
Cryptocurrencies have been in functioning for a while now, and can provide you with knowledge on its position in the market. There is greater awareness about it, and its risks are constantly being evaluated by users. Central bank digital currency does not yet have the requisite policy or institutional structures in place for its usage.
It will be a period of time before you are able to use CBDCs with the same ease that you could perhaps today buy cryptocurrencies in India. Owing to them being government regulated, it could very well be years before they are in circulation as commonly as say Bitcoin is.
CBDCs however, in a long run, do offer some benefits. Their development could help create an alternate channel of transactions to be conducted along with greater access. It would result in a successful translation of a state regulated entity into a digital medium. Thus, the level of security it would offer would be then higher.
The downside to this however, being that owing to no policy on the matter having been contemplated yet, this could take a long time to materialize. Even then, considering CBDCs are nascent to the digital market whereas cryptocurrencies have become a common entity today.
Lastly, even with central bank digital currency being introduced, it would be a new avenue in financial systems altogether. It does not have any existing models to replicate either. Its success within the economic market can only be ensured through a process of trial and error of government policy. Which is what makes them susceptible to security concerns in the current market even more so than cryptocurrencies.
There is also a greater understanding of the larger repercussions of cryptocurrencies than there currently is on central bank digital currency. The markets seeking to buy Bitcoin is only going to grow exponentially, more so with the introduction of CBDCs. Exciting times ahead!