Guide to Central Bank Digital Currencies (CBDCs)

While many countries are exploring the idea of implementing digital currencies, China is getting set to roll out its digital yuan, which will represent the first Central Bank Digital Currency (CBDC). China is leading the charge in both the development and implementation of this new digital currency, captained by the People’s Bank of China. This guide will look at what CBDCs are and how they differ from cryptocurrencies. It will also cover how the digital yuan comes into the picture and what CBDCs mean for the future of the digital economy.

What is a CBDC?

Like fiat currency, central bank digital currencies (CBDCs) are issued by central banks or reserves. These are essentially the central authorities that manage the currency and monetary policies of a country or state. Instead of printing physical cash, central banks issue CBDCs as private digital currencies.

The purpose of these CBDCs is to transfer value via digital transactions, all of which occur on a private blockchain network (also referred to as permissioned blockchain networks).

The innovation of CBDCs is seen as the next step to address the flaws that are currently in place between the digital and analog infrastructure. According to a report by Ripple, the company behind the bank-friendly cryptocurrency XRP, the primary goals in CBDC creation are “overcoming limitations of existing payments infrastructure, promoting financial inclusion, boosting competition or fostering innovation”.

CBDCs vs cryptocurrencies: what’s the difference?

CBDCs and cryptocurrencies are both digital currencies, but that’s where the similarities end. The biggest difference is their use cases, decentralization, blockchain types, and anonymity.

While crypto can be used to pay for goods and services, much of the interest in these cryptocurrencies is to trade for a profit with the speculation that the price of the asset will increase in the future. CBDCs, on the other hand, are solely able to be used for monetary transactions. The rules surrounding CBDC transactions are decided by a central bank. In contrast, crypto rules are at the whim of the user database who must reach a consensus on any major decisions.

The identity of CBDC users will be available the same way a standard bank account user’s details would be to that central bank, unlike the anonymity of cryptocurrency users. This comes down to blockchain types. While CBDCs use the centralized structure of permissioned blockchains, cryptocurrencies use public ones.

CBDCs vs. stablecoins

Although CBDCs and stablecoins are functionally similar, as they both represent fiat in the form of a digital coin, CBDCs and stablecoins are rather different. Stablecoins are typically handled under a private entity, like a company, and are not monitored or controlled by a country, unlike CBDCs.

Will CBDCs replace the currency we use today?

Most countries consider digital currencies to be an additional form of money, rather than a substitute for the existing financial infrastructure. This may change in the future, however, if the use of CBDCs is deemed to be a success.

What is the digital yuan?

China’s central bank, the People’s Bank of China (PBoC) is in the process of developing the digital yuan, which is a version of the normal Chinese currency, except it will be deployed on a blockchain. It is legal tender, which means it must be legally accepted if offered in payment of a monetary debt (i.e. paying for goods or services, paying a tax bill).

At the World Economic Forum, China’s project lead for digital trade stated that “the use of cash is decreasing. Eventually, cash will be replaced by something in digital format. That is one of the big drivers behind this.”

Already leading the way in being a minimal-cash society, the digital yuan will only speed up the process of this within China.

How will the digital yuan work and be implemented?

Real-world trials have already begun for the digital yuan in Chinese cities including Shenzen, Suzhou, and Chengdu. Already, millions of dollars worth of digital yuan have been distributed through a lottery system. Some of China’s biggest e-commerce platforms participated in these trials.

In practice, the PBoC will distribute the currency to the nation’s commercial banks. They in turn will pass it on to the people through the exchange of physical currency.

How will digital yuan and other CBDCs impact us?

The potential impacts of CBDCs are vast. China has some of the highest percentages of bankless individuals in the world. The CBDC gives these individuals access to banking infrastructure.

CBDCs also offer more efficient payment systems and infrastructure, by improving the speed and efficiency of payments. Simultaneously, they also offer the ability to foster innovation while encouraging competition by reducing barriers to entry to access global markets.

It is speculated this is the first step in our transition to a cashless society, not just within China but globally.

When will we be able to use CBDCs?

China launched its digital yuan pilot on Jan 4, 2022. It is anticipated that the full launch will occur in the first quarter of 2022. Given this, it’s highly likely that China will be the first country to issue a CBDC that is available to all its citizens.

China’s financial infrastructure, and current domination with blockchain technology, means that they are far ahead of many other nations in releasing these new currencies. Development actually began on the project in secret back in 2014, when it was known as Digital Currency Electronic Payments (DCEPs). 

In October 2019, President Xi Jinping laid out the government’s five-year plan for spearheading blockchain adoption, in an unprecedented speech that no other nations had given before.

Given the “complicated” relationship between the West and China, it’s safe to say that the digital yuan won’t be readily available to people in Australia, the US, and Europe.

CBDCs in US, Europe, and Australia

The United States Federal Reserve (the central bank of the U.S.) is currently looking into the possibility of developing its own digital currency. They are in the process of releasing a research paper that explores a move from the traditional U.S. dollar to a digital version.

The European Central Bank (ECB) distributed a report in 2020 that proposed the concept of a digital euro and is still deciding whether to pursue a formal CBDC project.

Australia’s central bank, The Reserve Bank of Australia (RBA), is partnering with the largest bank in the country, Commonwealth Bank to explore the implications of a CBDC using distributed ledger technology.

Summary

Central bank digital currencies (CBDCs) are digital versions of fiat currencies that run on blockchain networks. China’s digital yuan is likely to be the first CBDC in the world, which we should see in the first quarter of 2022. What remains to be seen then, is whether there’s another major world economy that will follow China’s lead and what that will look like. If you want to learn more about blockchain technology, stablecoins, or anything else crypto-related, there is plenty of excellent content on Swyftx Learn.