Central Bank Digital Currency (CBDC). What is it and why should it exist?

Central Bank Digital Currency (CBDC). What is it and why should it exist?

By Allen Walters | Publish0x posts | 21 Oct 2020


You might have heard about it before: Central Bank Digital Currency (CBDC). CBDC is a concept that is still in development at this point of time. CBDC is what is supposed to become the digital form of banknotes. First thing to realize is the fact that this is different from the money on your digital bank account. Even though both are digital forms of money, the difference lays in the fact that your bank account is an account at a commercial bank. They hold Central Bank money for you. You can not have a bank account directly at the central bank. The only way for you to hold actual money today, is to have physical banknotes in your possession. The money on you digital bank account is simply a claim you have on your bank. A claim that you can withdraw banknotes: it is a claim that you can withdraw actual central bank money. CBDC will change that. With CBDC, you can own digital banknotes. But today, if you have money on the bank, you don't actually own Central Bank money, you simply have a claim on your commercial bank. Not your banknotes, not your money. 

Somehow sounds vaguely familiar? How about this: Not your keys, not your coins. Rings a bell? This obviously is a well known phrase that is repeated a lot in the cryptocurrency community. It means that if you do not own the private key that controls the cryptocurrency that you bought, then you do not actually own the cryptocurrency. You merely have a claim on the exchange that holds the coins for you. If the exchange somehow collapses, you run the serious risk of losing your cryptocurrency. If you have the private key yourself, you have actual control over your cryptocurrency straight on the blockchain. Controlling the private key of your crypto, is like holding your banknotes in your own hand.

So if a commercial bank or exchange collapses, you have a claim on en entity that can not pay you what they owe. And although banks are way more regulated and insured than most crypto exchanges, there is always a risk that your bank might collapse one day. Some banks have done so during the last big financial crisis.

Now you might get the picture of why CBDC is something that could be interesting. You can't have a bank account at a Central Bank today. But you could hold some Digital Bank Currency in the future.

CBDC is not meant for daily payments
CBDC is not meant for daily payments. The purpose is to create more stability in the financial system that is moving closer and closer towards a 100% digital system. If no one owns anymore banknotes, the whole entire financial system is build on people having claims on commercial banks. This means that a 100% digital financial system will be a system that is build on 100% trust in commercial banks. If people barely own any actual banknotes, what happens in times of heavy political instability (locally or world-wide)? What happens if people lose trust in commercial banks? Crypto enthusiasts might cheer that and encourage everyone to buy crypto. But the fact is that the collapse of the financial system causes chaos and quite likely the collapse of the basis of an entire country or worse, the collapse of an entire region. If people can own Digital Central Bank Money, as a buffer or as part of their savings, it would be a financial fail safe mechanism in times of extreme political unrest or in times of a financial crisis.

Another reason to create a digital option for just anyone to directly own Central Bank Money, is the fact that banks grow bigger and bigger, and that some of the bigger banks create a monopoly-like situation where they gain to much power. CBDC would make people less dependent on these big commercial banks and restore some of the balance. With a CBDC, people would be able to go straight to the Central Bank for a part of the financial services they now only can get at commercial banks: storing value in a safe way, and cross-border payments. 

Cross-border payments is another example where CBDC can have an advantage over commercial banks. Anyone that knows cryptocurrencies knows that there is no such thing as borders when transferring actual digital money. But in the world of banking, this is a novelty off course.

So to put is short: a CBDC can restore the balance in a world that becomes more and more focused on digital services. 

The first CBDC will be followed by many
Once one big world player has its CBDC up and running, others can't lag behind long. If one big player takes the lead it would create too much of an imbalance in power within the global financial system. And it's not just the inflow of value towards that particular CBDC. Think about the data that can be collected through these digitally stored value transactions. One rival state can't have another rival state collect that data over it's citizens without providing them the option to use a native CBDC. And maybe there is something worse than a rival state that citizens need to be protected from: how about private entities. Projects like Libra, the stablecoin-like digital currency that Facebook aspires. You might ask yourself if people are still worth saving if they would consider to use a digital currency that is controlled by Facebook. But that's an other discussion entirely.

CBDC experiment for Banque de France and Tezos
CBDC will not necessarily run on blockchain. But since decentralized blockchain has many advantages over traditional digital ledgers, blockchain is obviously in the running as a serious competitor in the CBDC race. The biggest news the past months was the fact that Tezos is officially working with Societe Generale – Forge on the CBDC program for Banque de France. Societe Generale – Forge is one of the eight competitors that has advanced to the next round of the CBDC experiment for Banque de France:

"The presence of Nomadic Labs and Tezos technology in this selection highlights the quality of Nomadic Labs’ research and development teams, and the strong technical fundamentals of the Tezos blockchain. Based in Paris, Nomadic Labs counts several years of experience working on the development of the Tezos blockchain, as well as promoting its adoption. The Nomadic Labs team is integral to the development of the core Tezos protocol and native smart contract language which contain features – such as on-chain governance, a consensus algorithm based on Proof-of-Stake, and the ability to facilitate formal verification of smart contracts. These features make Tezos an ideal long-term solution for high-value financial applications." - Source 

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Allen Walters
Allen Walters

Fascinated by blockchain and future proofing cryptocurrency. Discover the tech before it gets relevant. Twitter: @IgnoranceIt


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