One of the most disruptive inventions in the financial sector was the rise of cryptocurrencies such as Bitcoin and Ethereum. Satoshi Nakamoto, the creator of Bitcoin, created the token to serve as an alternative to fiat currencies. He aimed to develop a decentralized financial system that would be independent of central banks, governments, and other financial institutions.
Cryptocurrencies have been a success thus far. Bitcoin is quickly becoming the primary medium of commerce, store of value, and investment asset.
However, the emergence of digital currencies has come at the expense of fiat currencies. This indicates that traditional financial institutions are losing their economic stake. The function of the central bank in controlling the money supply is reduced, while the government loses taxes. Commercial banks also lose money because most crypto transactions take place on peer-to-peer platforms and decentralized exchanges.
Cryptocurrencies have become a threat to traditional finance. It is only logical that governments will develop a strategy to combat the crypto menace. It is the central bank digital currency (CBDCs) in this situation.
CBDCs are fiat currencies that have been tokenized. It enables any fiat money to adopt crypto properties such as blockchain operations and ledger recordings.
What is the current situation with CBDCs?
Most governments are bullish on the prospects of CBDCs since they are the greatest method to mitigate the effects of digital currencies. China is one of the world’s top economies to have embraced CBDCs. The People’s Bank of China began testing with CBDCs in 2019. It disbursed about $5.3 billion as part of the preliminary experiments and is now pushing for the whole community to use the digital Yuan.
Other Asian countries, such as Cambodia, Malaysia, and Japan, are hoping to follow in China’s footsteps by experimenting with their own CBDC. Ground X has already been contracted by the Bank of Korea to assist with its CBDC trial.
European countries such as Australia, Canada, and the United Kingdom are also looking into the potential of CBDCs. According to a Bank of Canada assessment, CBDCs are beneficial to the country since they give citizens with non-bank deposit options and aid in the battle against anti-competitive and monopolistic behavior.
Nigeria is the first African country to establish a CBDC. It launched the digital Naira to provide a secure choice for Nigeria’s crypto-active population.
CBDCs for routine usage are becoming more viable and realistic, and various governments are showing interest. According to the International Monetary Fund (IMF), more than 110 nations are investigating CBDCs.
Why a CBDC makes sense
A CBDC issued by the central bank or another government body has the power to transform the economy. It will affect and benefit millions of people within the countries, as well as trading partners.
The convenience of accounting and reporting is the first way CBDCs will affect the economy. CBDCs, like cryptocurrencies, will function on the blockchain with a public ledger. The ledger keeps track of all transactions, allowing the government to plan and alter the fund’s supply to balance the economy. The data can also be used by the government in the event of an economic downturn.
Another advantage of a CBDC is the simplicity with which it may be updated by the general public. Some people have failed to adopt cryptocurrencies due to a lack of knowledge about their operation and use cases. Fiat currencies, on the other hand, are used by practically all citizens of a country. They are already well-known and widely used. As a result, most people will gladly accept them in the form of CBDCs.
The regulatory certainty provided by CBDCs is an extra benefit. Because most nations are still developing legal frameworks, the crypto community has battled with a lack of legislative clarity. The ever-changing crypto world, with new tokens and projects appearing on a daily basis, makes it difficult to control.
CBDCs, on the other hand, are likely to employ the existing legal structure for fiat currencies. They are also supposed to bring stability to fiat currencies. Even while cryptocurrency has entered the mainstream, volatility remains a concern, making it difficult for some firms to accept it as payment. The lower volatility and government support will entice more individuals and merchants to use CBDCs.
The CBDCs’ introduction is anticipated to benefit the corporate sphere as well. A blockchain analytics firm, for example, can quickly choose transactions and analyze the accompanying financial statements within a certain sector. It can then share the information with industry participants in order to develop proper business strategies.
Adopting CBDCs benefits the entire blockchain network. It would imply the network’s legitimacy, which would broaden the scope of other blockchain-based applications such as NFTs, decentralized financing, and DAO.
Some financial professionals have expressed reservations about CBDC’s initial and incremental investment requirements. That, however, has proven to be an incomplete picture of the product. Digital currencies and virtual currencies are already the norm, with e-commerce increasing at a rapid pace in recent years. CBDCs can benefit from the same widely utilized infrastructure that allows digital currency transactions. Stablecoins are being developed or supported by financial institutions such as PayPal and Visa. This indicates that fiat currencies can be supported on blockchains.
That is not to argue that CBDCs are without risk or difficulty.
CBDCs’ negative aspects
One of the key issues raised by most crypto enthusiasts is that CBDCs do not adhere to the concept of cryptocurrency. Decentralisation was central to digital currencies. They were designed to eliminate the power of a few individuals or government agencies over the economy. Because CBDCs are fiat currencies that run on blockchains, the centralized operating structure remains in place.
The risk of inflation is another source of anxiety. Because of COVID-19, the world is experiencing severe inflation as a result of the economic crisis. One of the causes of high inflation is government policies such as printing more money. With complete government control, the government may produce as many CBDCs as it wants, regardless of the consequences such as inflation.
So far, Bitcoin has nearly displaced gold as an inflation hedge. This is mostly due to the restricted supply of Bitcoin. BTC operates in such a way that supply remains constant regardless of demand. Without such regulations for CBDCs, there is a possibility of financial regulatory exploitation of consumers.
Already, the Nigerian CBDC launch has demonstrated how governments can utilize it to dominate the economy without regard for consumer interests. The government was all about censoring information at the time of the debut of the digital Naira. It only allowed a few media outlets to attend the launch, and no questions were permitted. Simultaneously, no specific information on development or supply was provided. This occurred at a time when the government had already prohibited the use of Bitcoin.
The government may presently monitor and freeze bank accounts at will, and the same can be said about CBDCs.
What are CBDCs and what do they mean for cryptocurrencies?
Bitcoin and other digital currencies have entered the mainstream financial market. Other than people and merchants, countries such as El Salvador have declared Bitcoin to be legal money. However, they are not without drawbacks, such as high transaction costs, slow transaction speeds, and environmental problems.
CBDCs are attempting to address existing digital currency challenges. Furthermore, governments are expected to implement recovery methods for people who send money to the wrong address, as well as ID-checking to recover lost wallet keys.
CBDCs are expected to attract a large number of consumers fast due to their clear regulatory structure and government backing. Once launched, decentralized cryptocurrencies may face direct competition from CBDCs. Most cryptos may struggle because their value depends on widespread adoption.
The CBDC’s introduction may also have an impact on crypto legislation. So far, most governments have backed cryptocurrency and allowed unfettered crypto trade. This is expected to alter once CBDCs are implemented. For example, it is widely assumed that the primary objective for China’s crypto crackdown was to clear the way for the Digital Yuan.
To avoid direct competition from decentralized cryptocurrencies, most governments are likely to outlaw them or impose restrictions on their use. This will slow the growth of cryptocurrency and the creation of new enterprises.
The question of whether CBDCs are helpful or bad for cryptos remains unresolved. On the one hand, governments’ acceptance of CBDCs validates blockchain technology. It would provide the necessary assurance for the development of various blockchain systems, such as NFTs and decentralized finances, which already rely on cryptocurrencies for operations. Growth would imply an expansion of the primary tokens of the respective platforms.
On the other side, the introduction of CBDCs would result in direct competition between centralised and decentralized currencies. The government can restrict or limit digital currency in order to win.
As a result, only time will tell whether CBDCs are beneficial or detrimental to cryptocurrencies.