Crypto investors neither trade nor live in a bubble. Their market is closely watched by institutions and organizations who fear that decentralized assets might usurp them. To counteract the disruptive technology, banks have thought of creating a digital currency of their own: a Central Bank Digital Currency (CBDC). But what is a CBDC?
CBDC is not a new word in the vocabulary of the average cryptocurrency lover. However, it is a word that is definitely being used more frequently than what we are accustomed to.
We have news and updates about CBDCs almost every week, which leaves many wondering what the ‘hype’ is all about. After all, is it not that banks, politicians, and monetary experts hate anything having to do with digital currencies like crypto?
The situation is not that simple. While those with the highest powers dislike the freedom that decentralized and digital assets create, they still love blockchain technology (specifically permissioned networks) and all that it offers.
After the previous bull run, Bitcoin and other assets were bleeding for the entirety of 2018. During that time, enterprises and other large companies silently began creating blockchain-powered solutions that had the potential to outperform legacy systems.
Similarly, while investors were euphorically celebrating Bitcoin’s parabolic rise for a majority of the last decade, financial institutions were (far earlier than corporations) researching ways of mixing blockchain technology and fiat currencies.
How did that journey start, and which countries took the first initiative? Furthermore, what is the premise of CBDCs, and how are they different compared to cryptocurrencies?
Inspired by Bitcoin’s success, central banks from all parts of the world began to research and openly discuss the prospect of central bank digital currencies around 2015.
It is important to note that while this time period marked the first moment that the idea of CBDCs surfaced, undisclosed research and talks were most likely held far earlier. The Cypriot financial crisis of 2013 was a turning point in Bitcoin’s adoption, and it probably also led to a shift in how seriously banks perceive decentralized currencies.
But be it official or unofficial, we divide the history of CBDC based on where they were researched the most: west and east.
In the west, the idea was talked about for the first time in September 2015 by Andrew Haldane, the Bank of England’s chief economist. During a speech, he proposed CBDCs as a method of implementing negative interest rates. A year later, the central bank’s deputy governor of monetary policy also held a speech on central bank digital currencies.
Apart from the UK, only a few other countries scattered around the world have mentioned CBDCs. Between 2016 and 2017, only Ecuador, Uruguay, and Sweden have discussed such currencies.
The first decisive move occurred in 2019 when the European Central Bank (ECB) announced that it plans to assess the benefits and effectiveness of a CBDC. As we will explain later, Europe was pushed to do so as a global corporate stablecoin threatened the Eurozone.
In 2020, the ECB published a report on the digital euro. The document reveals that the central bank will finish experimenting with numerous concepts, regulatory frameworks, and ideas by mid-2021. After that point, the ECB plans to start developing the digital euro.
In the east, the People’s Bank of China (PBoC) took the initiative and outpaced everyone else. Not only did China progress far faster than its close neighbors, but it also managed to leave the western world dumbstruck.
China’s central bank has been working on the digital yuan as early as 2014. At the time, the PBoC hired a team of researchers to work on a project called DCEP (Digital Currency Electronic Payment). While this still remains the project’s official name we will refer to it, as most do, as the digital yuan project.
In later statements made by the bank’s representatives, we have found out that research alone lasted for four years. It was only in 2018 when the PBoC began to design the digital yuan as well.
With extra time on its hands, the Chinese government spearheaded CBDC research, and by 2019 it was capable of launching the first tangible network. In October, President Xi Jinping held the famous ‘blockchain speech.’ Xi effectively announced the start of a new policy that will drive nation-wide blockchain adoption.
Later on, he also announced the launch of a beta phase of the Blockchain Service Network (BSN). Representing the critical infrastructure that supports the digital yuan, the BSN completed its beta phase 6 months later.
A CBDC is a blockchain-based digital currency issued by a central bank. Since they are in an incredibly early phase, most individuals can only speculate about the possible features and characteristics of CBDCs. For now, no such digital currency has been launched.
The clear exception is China’s digital yuan. However, this CBDC is still being experimented on, and there is no official information regarding the currency’s design. Given the nation’s modern environment and situation, we can safely assume that the new yuan (or rather its blockchain) will be private and designed for commercial online payments.
Defining the exact details of a CBDC is difficult at the moment. Nevertheless, various reports and statements released over the past few years can point us in the right direction. The European Union and China have been the main contributors so far, and their proposed or imagined design can tell us more about how CBDCs work.
While China has been ironically more public about its project, we will primarily use the European Union and the European Central Bank for the sake of this article. We plan to showcase China’s expansion into the field of CBDCs in a later post.
Last year, the Bank for International Settlements (BIS) held a survey to find out the level of engagement and interest that central banks have in digital currencies. The results showed that a staggering 80% researched, experimented with, or actively developed CBDCs.
The BIS stated that Facebook’s announcement of the Libra corporate stablecoin in 2019 turned into a tipping point for CBDC interest. Central banks feared that Libra would negatively affect not only the monetary stability of individual countries but of the entire world. As such, they have started to slowly pressure the social media platform while working on solutions of their own.
The report also claims that the number of central banks that planned to launch a CBDC in the next six years doubled in 2019.
Strangely enough, it appears that Bitcoin had a low influence on the introduction of state-owned digital currency. This may have happened because banks understood that the IT giant and major social media platform could leverage its user base to turn digital currencies mainstream.
Although they use the same technology, a CBDC is implemented in a radically different way as opposed to cryptocurrencies. To better understand the nature and future of bank-issued digital currencies, it would be best to first learn about what makes them so distinctive.
The first major difference is that banks use permissioned (private) rather than permissionless (public) blockchain networks. Right from the start, we see that CBDCs are not decentralized and that they lack a fundamental feature common in most modern blockchain networks.
Every single cryptocurrency that you have encountered on the market is public. Everyone can create a node and read all the transactions that were ever made. You require no special permission from a centralized entity, nor is there one.
CBDCs, and permissioned networks in general, are vastly different. For the sake of not publicizing a vast amount of private and often critical financial information, central banks use private networks that not anyone can access.
Not everyone has the right to view data from the CBDC’s blockchain network. The central bank has to specifically grant another bank or another financial institution permission to join the network.
Is there any anonymity or at least pseudo-anonymity on CBDC networks? Certainly not.
Central banks treat digital currencies in the same way as digital payment systems. They are implemented solely to scale and digitize existing online payment networks, making transactions cheaper and settlement times faster.
You might receive one side of the benefits that cryptographic technology has, but you will not receive the whole package like with cryptocurrencies.
In the report on the digital euro, the European Central Bank stated the following:
“Anonymity may have to be ruled out, not only because of legal obligations related to money laundering and terrorist financing, but also in order to limit the scope of users of the digital euro when necessary – for example to exclude some non-euro area users and prevent excessive capital flows or to avoid excessive use of the digital euro as a form of investment.”
Cryptocurrencies are decentralized in the sense that everyone can join a blockchain network and equally participate with other users. There is no centralized entity controlling these digital assets. Only the miners, which everyone can become, with their nodes can verify transactions and establish the official version of the network through consensus.
In the blockchain of a CBDC this is not the case. As we have previously stated, their network is permissioned, and central banks control who has access. Think of it as a glorified cryptographic and centralized data center rather than a blockchain network.
As we have seen, CBDCs do not share most of the features that cryptocurrencies have. Believe it or not, the same goes for use cases as well.
You can use crypto both for payments and for speculative purposes. On the other hand, digital currencies issued by central banks can only be used for payments. Users cannot purchase CBDCs for the sake of investing just as if they would with cryptocurrencies. They may attempt to do so, but the bank will do everything possible to make investing as unprofitable as possible.
Let us again take a look at what Europe has to say with their CBDC report. Last fall, Europe’s largest monetary authority revealed that it would limit the use of the digital euro as an investment for a number of reasons.
One part of the digital euro report reads:
“The digital euro should be an attractive means of payment, but should be designed so as to avoid its use as a form of investment and the associated risk of large shifts from private money (for example bank deposits) to digital euro.”
The ECB stated that it would introduce tools that limit the use of a digital euro as an investment. While there are no specific details of the mechanism, the paper mentions a threshold that prevents citizens from accumulating large sums of the CBDC.
Based on the paper’s content, it seems that there is no clear decision on how to implement the restriction. While not directly presented, the central bank most likely has many options in mind.
What is a CBDC? A digital currency issued by central banks. Inspired by Bitcoin’s sudden success in 2013, the world’s largest financial institutions quickly started to research ways of how to improve legacy systems with the help of blockchain technology.
CBDCs and crypto represent completely opposite sides of the spectrum. One is private; the other is public. One is centralized; the other is decentralized. One is reserved for payments, the other for payments as well as speculative assets. Simply put, there is nothing that connects these two except the use of cryptographic technology.
Initially, a majority of cryptocurrency enthusiasts believed that CBDCs would bolster the position of cryptocurrencies and even help them with achieving widespread adoption. However, it became more evident as time passed that CBDCs will not aid crypto but replace it.
Both digital currencies can exist side-by-side, as long as institutions do not kill cryptocurrencies with regulations. Will they? No one knows. But history has shown that central banks fear corporations far more than decentralized assets.
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