Understanding CBDCs: Benefits, Drawbacks and What They Mean For You

As transactions with paper cash continue to decline rapidly, the governments of many countries have started exploring ways to modernize their electronic payment systems. So far, Central Bank Digital Currencies (CBDC) seems to be one of the most viable initiatives. 

But what exactly are CBDCs, and how do they work? Moreover, are CBDCs beneficial to business owners and individuals in any way?

This guide answers everything you need to know about CBDC.

What Are CBDCs? 

Central Bank Digital Currency (CBDC) is a digital version of a nation’s fiat currency. It is often built on distributed ledger technology (which works the same way as blockchain) and issued by the country’s central bank. 

Although CBDCs are built on decentralized technology like cryptocurrencies (Bitcoin, Ethereum, Dogecoin), both are quite different from each other. For instance, crypto coins are volatile and issued by private companies. On the other hand, central bank digital currencies are stable and backed by the central bank. 

Similarly, CBDC shouldn’t be confused with electronic bank deposits. The latter is just a digital representation of the money in your commercial bank accounts. As such, they are controlled by your local bank authorities. However, CBDC is directly regulated by the central bank, making them safer. 

How Does CBDC Work? 

The Central Bank Digital Currency Tracker reveals that most CBDC projects are still in development, making it difficult to provide a clear-cut framework on how they work. However, here are some critical facts about how some of the CBDCs in circulation work: 

Sand Dollar: The Sand Dollar was the first ever CBDC to launch. It was developed by the Central Bank of Bahamas in 2020 and is distributed to the public through authorized local financial institutions. 

The Sand Dollar is built on blockchain technology and uses a peer-to-peer transaction model so that users can transfer it to each other.  

To make the currency more accessible, the government made it available on mobile wallets. This way, anyone with a smartphone can download the wallet, create an account, and access the CBDC. Alternatively, users can also spend Sand Dollar via physical card – a reliable way for low-internet internet regions to access the currency. 

e-Naira: The e-Naira is the Nigerian Central Bank’s Digital currency, and the first of its kind in Africa. It was released in 2021 by the country’s apex bank and circulated through local commercial banks. 

The Digital Naira was built on a Distributed Ledger Technology (DLT), and offers swift transactions like cryptocurrencies. Users can easily access and spend it via mobile wallets without going to banks to create an account.

e-CNY: The most successful CBDC so far is the China Digital Yuan issued by the People’s Bank of China. 

The Digital Yuan is still at the pilot stage but has already gained massive popularity since its use during the 2022 Winter Olympics. Two years later, e-CNY is still thriving and has recorded a combined transaction volume of Rmb7.3 trillion (US$1 trillion). 

The e-CNY is built on a non-DLT technology that makes it accessible to the public but controlled by the government. It was circulated through local banks and mobile payment wallets like Alipay and WeChat Pay. 

To make it accessible to all, it was developed so that people could access and spend it whether they have internet or not. 

4 Top Benefits of CBDC 

CBDCs promise many potential benefits for the government, entrepreneurs, and individuals. Here are some of them: 

Financial Inclusion: Due to the profit-driven nature of commercial banks, banking halls are scarcely available in many rural areas. Therefore, this excludes rural residents from the current financial system. However, by using a peer-to-peer transaction model, CBDC will provide financial inclusion to everyone who has a smartphone. Now, it’s easy to downplay the role of inclusivity in nation-building and economic prosperity. However, a closer look at how a better saving model gave Malawi farmers more funds to procure tools and boost crop yield and earnings by over 20% would help you appreciate it better. 

Quick Remittances: Thanks to the power of the blockchain, CBDC transactions are fast and near-instant. Thus, CBDC enables business owners to send and receive real-time cryptocurrency payments and streamline business operations. 

Cheaper Transaction Cost: With many intermediaries involved in money flow, transaction fees are often high and eat into business owners’ profits. CBDC excludes third parties from money flow, making transactions cheaper and boosting businesses’ profitability. 

Improved Fiscal Policy: CBDC enables the government to track how money is exchanged and how people spend it. This, therefore, fosters better budget planning and the formulation of efficient economic policies that improve people’s lives. 

Drawbacks of CBDC 

Although CBDC offers several benefits to users, they could be better. Here are some of the concerns that may plague CBDC adoption: 

Privacy Issue: With the government’s ability to track and monitor CBDC transactions, privacy invasion is one of the most dreaded headaches with using CBDC. This issue can hugely affect nonprofits whose clients prefer to make anonymous donations without the public’s knowledge. To protect users’ privacy, many apex banks like the European Central Bank are proposing simple CBDC models that give users anonymity, especially for low-volume transactions.  

Security concern: CBDC design concentrates a nation’s wealth in a single body (the central bank). This can make the central bank and CBDC infrastructure the constant target of cyber criminals looking to steal public funds. 

Economic Disruption: According to the Bank of International Settlement (BIS) study, retail CBDC rollout may significantly reduce bank deposits. This reduction in customer deposits will affect banks’ profitability and entrepreneurs’ access to cheap loans, among other economic challenges. 

Inflation Risk: There is also the concern that careless rollout of CBDC could lead to too much money in circulation and eventual inflation. Central banks must adequately plan CBDC launch and distribution to annul this issue. 

Final Thought: What Is Next? 

Fiat currency digitization is no longer an imaginary concept. The governments of the Bahamas, Nigeria, Jamaica, and Zimbabwe have already launched digital versions of their currencies. Similarly, many countries like China, India, and Russia have made significant progress in their CBDC development, and other top nations are looking to follow in their footsteps. 

When CBDC arrives, the unbanked will have financial inclusion. Similarly, merchants will enjoy cheaper transaction fees and record-fast remittances, which may help boost their bottomline. 

To be fair, CBDC also poses some concerns, like the possible disruption of the current financial system and user privacy invasion. Luckily, these challenges are foreseeable and can be annulled with proper planning and robust regulations. 

So what should you do next? While there is no denying that a digital payment revolution is upon us; the shift from cash to CBDC will take time to arrive. To prepare for the future, continue exploring various digital asset classes and their economic relevance.