CBDC vs cryptocurrency: Which type of digital currency is better and should we look forwards to the eventual launch of bank-issued digital currencies? The differences between them are critical and for the right reasons, we may have to be wary of any future institutional interactions with blockchain technology.
On February 24, Federal Reserve Chairman Jerome Powell spoke before the House Committee on Financial Services and stated that 2021 would be an important year for the digital dollar project, noting that the central bank will engage with the public on the matter.
Powell’s statement presents a wide contrast in comparison to his early remarks from 2020 and previous years, a period during which he relativized the digital dollar’s importance. Yet again, we see public statements do not mirror the factual state and stance towards blockchain technology which is often discussed behind closed doors.
As discussed in our past articles on CBDCs, digital currencies are at the forefront of this decade’s agenda. Central banks from all parts of the world, mainly the EU, U.S, and India, seek to implement their own blockchain solutions in order to counteract the rise and widespread adoption of blockchain technology.
What is the exact difference between ordinary cryptocurrencies, which are popularly used today, and future central bank digital currencies which are yet to launch? Are both solutions decentralized, and if not, which one will take over the world?
Before comparing the two, let’s quickly explain both digital currencies for the sake of having additional context.
What is a CBDC?
A central bank digital currency (CBDC) is a blockchain-based virtual currency issued by a central bank. Since no CBDC has been launched yet, we can only speculate on their design and how they actually work. Nevertheless, a few official sources can help us with pinpointing the exact details and provide us with a clearer picture of how a CBDC should look like.
By deriving data from the European Central Bank’s report on the digital euro, along with news reports related to China’s digital yuan, we can conclude that CBDCs are private digital currencies created for the purpose of transferring value via digital transactions. A more important use case lies in the field of the digital payment industry.
A CBDC has no investment value, and in some cases (ECB), the central bank will go as far as to punish hoarding or investment activities. Therefore, we see that digital currencies are designed purely for commercial online payments.
Another fundamental feature that we must observe is the type of blockchain network that CBDCs use. Since central banks naturally prefer not to publicly disclose transactions and other financial data over the blockchain (for either moral or immoral reasons), a CBDC is obviously enough based on a private blockchain network.
Alternatively known as a permissioned blockchain network, this type of ledger is completely different from its decentralized older brother. Network participants must have the privilege to observe and conduct activities in the blockchain, which is ordained by a central authority: in this case, the central bank.
In such a system, banks and other financial institutions that are partnered with the central bank would facilitate transactions for their respective clients by hosting nodes. Besides them, no one else would have a similar role or access to the permissioned blockchain.
Were public blockchains ever a possibility for CBDCs? Probably not. But the nature of a CBDC’s blockchain type can at least help us with deciding whether one should support them or not in comparison to cryptocurrencies.
What is a cryptocurrency?
Most blockchain enthusiasts are well informed about what cryptocurrencies are and how they work. But for the sake of providing additional clarity when later comparing them to CBDCs, let’s provide a brief yet detailed overview.
Cryptocurrencies are decentralized digital assets stored on public and permissionless blockchain networks. They either have a capped or unlimited supply, and in some cases, users can earn tokens by directly supporting the network - with the two most popular methods being mining and staking.
Everyone can join a crypto blockchain network and observe its state, even if they are not active participants. Moreover, users can become miners, and there is no set of requirements that prevents someone from hosting a node.
On a blockchain network like Bitcoin, all users are equal and hold the same rights, authority, and power. There are no special figures. Last but not least, the network flows by having all of its users reach a consensus on the state of the ledger.
In respect to use cases, cryptocurrencies are categorically both assets and currencies. Individuals can speculate on the price action of a cryptocurrency by participating in investment markets. Alternatively, they can use special projects like Bitcoin as a store-of-value asset in order to hedge against inflation and economic instability.
Those who wish to use cryptocurrencies as currencies can do so as well. Anyone can use Bitcoin or Ethereum to create transactions and make payments. Today, there are more vendors and shops that support crypto payments than ever before. With that in mind, decentralized digital assets have achieved the feat of acting as a form of online currency as well.
CBDC vs cryptocurrencies: core differences
As we have seen, there are, in fact, more than a few differences between central bank digital currencies and cryptocurrencies.
On the one hand, we have a centralized digital currency operated by a central bank whose blockchain network can only be accessed and interacted with by special financial institutions that have the necessary privilege. CBDCs can only be used as a means of payment, and any form of hoarding or investment activity is openly forbidden.
On the other hand, cryptocurrencies are decentralized digital assets that are hosted by a public and permissionless blockchain network which can be accessed by anyone. Users can utilize cryptocurrencies both for payments and for speculative purposes. There is no central authority capable of limiting their use. Moreover, their supply is traditionally limited, and it cannot be changed without the consensus of a majority of users.
To further clarify, let’s summarize the core differences between cryptocurrencies and CBDCs.
- Blockchain type. While CBDCs use permissioned (private) blockchains, cryptocurrencies use permissionless (public) blockchains. The former is a centralized structure, the latter is not.
- Anonymity. Cryptocurrency users enjoy anonymity. CBDC users will have their identity tied up to an existing bank account and an equal amount of personal information.
- Decentralization. On CBDC networks, a central bank decides the rules. On crypto networks, the authority is delegated to the user base, which makes decisions by reaching a consensus.
- Use case. CBDCs can only be used for payments and other monetary transactions. Cryptocurrencies can be used for speculative purposes and for payments as well.
Have you ever watched a movie remake? If not, maybe you have recently played a video game remake of a popular franchise? In both cases, the end result remains the same: the copy cannot beat the quality of the original.
The same is applicable to the battle of cryptocurrencies and CBDCs. Central bank digital currencies are simply a bad copy of the crypto assets that we use today. They only impose restrictions and limitations, rarely bringing anything to the table that might enchant someone and push them away from decentralized currencies.
Truth be told, there is one noteworthy difference that we have not mentioned: scalability. Since they run on permissioned networks, closely resembling databases, CBDCs can theoretically scale better compared to cryptocurrencies. So far, we did not have the chance to see if that is actually possible since no CBDC has launched yet.
But be it true or not, will anyone willingly give away their freedom for the sake of faster transactions? Blockchain developers from both the Bitcoin and Ethereum teams have existing scalability solutions that will improve with time, so why not wait a few years instead of jumping on the CBDC bandwagon.
Can they coexist?
The question of CBDC vs cryptocurrency is far deeper than pure performance. What you should rather ask yourself is whether both types of digital currencies can coexist.
Indeed, a number of nations have done great work on regulating and ‘institutionalizing’ cryptocurrencies. However, an obvious trend is that regulations are becoming increasingly stricter as central banks come closer to launching their own digital currencies.
This is apparent in the case of the Reserve Bank of India, an important central bank that pushes a nationwide crypto ban while working together with the government to implement regulations that would add legal support for the launch of a digital rupee.
If achieved, the ‘let’s ban crypto and introduce CBDCs’ strategy would create a precedent that could push other countries to do the same.
Banks could simply lobby against decentralized currencies by using the same old arguments that we have been listening to for nearly a decades:
“Cryptocurrencies destabilize a nation’s monetary system; they are used by criminals and drug dealers who launder money...and by terrorists as well!”
If we head in that direction, there is nothing that can stop the anti-crypto propaganda machinery. And if the masses fall for it, much like they fall for other traps lately, the existence of cryptocurrencies will be in real danger. Will we be able to stop it, or will TPTB reign supreme?
There is no good argument for supporting central bank digital currencies in the case of CBDC vs cryptocurrency. The positive side is that they will pave the way for further digital asset adoption. However, it may come at the cost of having traditional cryptocurrencies succumb to strict regulations and even outright bans.
CBDCs bring a range of setbacks, which devolve cryptocurrencies in a way that no one has been capable of before. Reasonably, we can praise them for their theoretical scalability, but that is nothing to be proud of when users lose their dear decentralization.