What is CBDC?
CBDC stands for "central bank digital currency," a new form of currency being tested by governments all over the world. The country's professional monetary authority issues and regulates a CBDC, which is a consolidated currency What sets a CBDC apart from other currencies is that supporters believe it would be able to leverage emerging payment technologies, such as a blockchain, to improve payment reliability and reduce costs.
How CBDC is different from cryptocurrencies?
CBDCs are automated equivalents of traditional money that are circulated and supervised by a country's central bank. Cryptocurrencies, on the other hand, such as bitcoin, are created by solving complex math puzzles and are controlled by a number of online parties rather than a centralized body.
Advantages of CBDC
CBDC will increase the reliability of the payment system as a virtually costless means of trade. For example, a recent IMF study showed that introducing CBDC would make cross-border financial transactions quicker and more stable. For families with lower incomes, which are heavily dependents on currency, and small businesses, CBDC will be of great benefit when paying by debit and credit cards, which incur high costs of processing cash or high exchange rates.
In add-on, if the global recession is extreme, CBDC may support local stimulus for the fiscal sector, Funds could be put on the CBDC low-income household accounts directly. Cushioning its acquisition capacity from the impact of the slowdown and the temporary negative CBDC levels.
The systematic use of CBDC and paper currency stagnation would discourage fiscal evasion, laundering of money and other criminal activity facilitated by fiat currency. In advanced economies, this advantage is significant, although still more important for developed countries where a substantial part of business activity is carried out with cash and there is a very high degree of tax evasion.
How CBDC can contribute to financial inclusion
Individuals typically obtain access to credit and the banking sector in the existing fiat currency system by checking and savings accounts located within banking system. However, not everyone is able to open a bank account. Financial services can be difficult to reach or flexible in developing markets, requiring people to rely on cash and barter networks. As a result, individuals in need of funds must resort to collateralized loans or nontraditional lenders such as microfinance associations and cooperatives. If the financial world grows more digital, those that are unable to obtain bank accounts in both established and developing markets will fall further behind.
Lack of wealth, a lack of financial education, prior defaults, incarceration, and immigrant status are some of the most common reasons of financial exclusion around the world. Racism, gender inequality, classism, colonization, authoritarianism, religious repression, and other types of injustice have all played a role in this.
CBDCs will help to reshape the financial system so that it is more available to the unbanked and underbanked. CBDCs are distributed directly to individuals by a central bank, bypassing conventional bank accounts. Its accounts are held directly on the central bank's core database for entities. They then use Application Program Interfaces to access and transact with their assets through an electronic banking application connected to the CBDC account (APIs). CBDCs will substitute or complement fiat currency, eventually solving a range of existing issues confronting unbanked and underbanked societies.
Challenges in Adoption
If non-banks consider CBDC to be superior to bank deposits, the implementation of CBDC can result in a replacement of bank deposits. This will result in a reduction in the bank deposit base and could limit banks' ability to finance credit operations. The exact effect on monetary and fiscal policy is unknown, but it can also be decided by whether the CBDC alters money market conditions.
CBDC is concerned with the transformation of bank reserves as well as key financial sector infrastructures. It will entail that central banks will continue to play a vital role in payments as they become more digitalized, and it will also serve as a mechanism for payment digitalization.