LeoGlossary: Central Bank Digital Currency (CBDC)

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A CBDC is a digital liability of a Central Bank.

These are similar to cryptourrency in that they are digital tokens. The main difference is they are issued by the Central Banks and do not use decentralized blockchain. Instead, they are issued and regulated by a nation's monetary authority.

The token is obviously pegged to the nation's currency since it is just a digital representation of what already exists. Thus it is considered legal tender.

CBDC's are subject to great debate. At present, nobody is sure how effective they will be.

There are two categories of CBDCs:

  • Wholesale which operate similar to Central Bank Reserves
  • Retail which allows the use by individuals and businesses

The thinking is that CBDCs will remove the intermediary risk associated with cryptocurrencies.

A big part of this equation comes down to the ledger. With blockchain, distributed ledger technology (DLT) is utilized. The responsibility for maintaining the ledger falls to the node operators. With a CBDC, the ledger will be controlled by either the Central Bank or the existing banking system.

CBDCs are designed to be an extension of the fiat currency already in operation. Being that it is programmable money, many fear that governments can enact sinister outcomes. For example, it would be possible to effectively introduce negative interest rates by having the money decrease (or disappear) if not spent in a certain period of time.

Retail CBDCs could present a challenge for the commercial banks. Under the fractional reserve banking system, depository institutions take in deposits. These are liabilities on their balance sheet. This is naturally offset by the cash, which is then put to use. Banks can either purchase government approved securities or make loans.

The challenge is that retail CBDCs will have a digital wallet. For most people this will handle the basic functions a bank serves:

  • sending money
  • receiving money
  • storing money

If the Central Bank is able to handle this direct, to conduct transactions on behalf of the general public, this cuts into the commercial banking system.

Thus far, both the US Federal Reserve and the Bank of Japan have failed to see the value of CBDCs for their currencies. The New York Fed is working with other entities on creating a wholesale CBDC for international transactions.

China has the most success so far with CBDCs. Most other countries that implemented them found the reception to be lackluster.

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