Central Bank Digital Currencies (CBDC): Ultimate Guide

Crypto investors everywhere are still feeling the impact of FTX’s controversial collapse last month. As a result, the event thrust CBDC (central bank digital currencies) into the spotlight. 

CBDC is at the forefront of the conversation on how to build the cryptocurrency industry back up in a highly regulated fashion. Governments are pushing for stricter and more secure crypto regulations after FTX - and several other notable platforms - failed in the past year.

While cryptocurrency has great potential, many argue it needs better protection. However, the debate on whether CBDCs are the answer remains unfinished. So, let’s dive deeper into what CBDC is if it will replace cryptocurrency, and how to prepare for its adoption if so.

What is CBDC?

While cryptocurrencies are decentralized, CBDCs operate as a fiat digital currency backed by reserves. CBDC is liable to centralized banks like the US Federal Reserve. Other digital capital, like our online bank accounts, is liable to commercial banks. People can use CBDC as a secure and convenient payment method. Governments can use it to stimulate the economy and monitor transactions. 

Is CBDC a currency?

CBDC only exists digitally. There are two kinds of CBDC, retail, which common consumers use for their exchanges, and wholesale. Financial institutions use this type of CBDC for special transactions. The currency takes the form of digital coins and banknotes. Numbers and images already represent your fiat currency in your online bank account. The difference is, you can transfer money from your online bank account to paper cash. With CBDCs, there will no longer be a paper cash option.

Is CBDC a threat to cryptocurrency?

In theory, using CBDC won’t devalue other payment methods, like cryptocurrency. In practice, the mass adoption of CBDC could cause lasting impacts on crypto exchanges. Countries may form new regulations for cryptocurrencies and DeFi platforms based on CBDC. CBDC records all its transactions in an encrypted database; a feature many crypto users love. It also prioritizes fast, real-time transactions and global exchanges without any annoying fees. 

CBDC Pros vs. Cons

Like with any other currency, CBDC comes with its advantages and disadvantages. These are as follows:

CBDC Pros

New use case potential

CBDC is not a crypto asset, but it can function like one. People can also use it like a fiat currency, essentially providing users with the best of both worlds. CBDC has the potential for both universal and limited access. This means it could become an acceptable currency globally, or remain country-specific. 

Cost-efficient method for storing value

CBDC has no hidden fees, nor does it cost anything to make, ship, or store, unlike other assets (like cash or gold). It’s also safer to store value in long term, as CBDCs are subject to their country’s regulations.

Convenient and fast

CBDCs are well-suited to both the general population and financial institutions. Consumers can download an app on their devices or visit a webpage to access CBDC. Imagine you are out shopping, have your hands full, and need to pay for your things. You can simply use your smartphone to make an instant transaction. You won’t have to check its current value or calculate how much to send. It also won’t cost you an added transaction fee!

Less volatility than crypto

Many digital assets experience more volatility than fiat currencies. CBDCs are inherently non-volatile, unlike many decentralized cryptocurrencies. They’re issued and regulated by a country’s central banks, who keep the currency stable. 

Increased transparency

Enhanced traceability of digital currency leads to increased transparency. The database recording all digital payments using CBDC can flag illicit actions. It will become easier to catch suspicious payments, tax evasion, and money laundering. This makes it safer for users who want to ensure their money is safe from criminal activity.

Supports economic growth and the crypto ecosystem

CBDCs can act as a healthy gateway for the continued development of crypto. People want to experiment with digital assets. If they feel like crypto is too risky, they can try CBDCs first. While technology sectors keep improving crypto, users can get used to digital cash. It provides a great transition for those who want to enter the crypto market.

Increases competition and innovation

Similarly, CBDCs can increase competition in the digital payments landscape. Both central banks and private groups can find the motivation to improve decentralized currencies. Banks will try to attract those with assets that can spill over into CBDCs. The crypto market can apply aspects that work in CBDC to crypto.

Improved access to digital payments 

Households without an online bank account and inexperienced in crypto can turn to CBDC. This can benefit the general economy, as more people will be able to take part in regular spending. CBDCs can also allow banks to offer short-term liquidity support. This benefits banks, as they can avoid losing liquidity. 

CBDC Cons

Restrictions by country

Governments can easily regulate CBDC, but this isn’t always a good thing. Cryptocurrencies allow users to escape financial regulations set by their country. For now, CBDCs are only accepted by the country that issues them. You can’t use CBDC to make international payments yet. 

Governments are also able to dictate the autonomy of CBDC users. They can collect user data, which they can use to inhibit all kinds of consumer behavior. For example, a country might want to cut a protest short before it makes major news. That country could put restrictions on CBDC accounts of prolific activists. Making it harder for activists to spend money or leave the country is a guaranteed method to keep them quiet.

Hindering loans

CBDCs can increase competition for central banks, but this might also cause decreased demand for deposits. Consumers might turn away from fiat currencies and invest in CBDCs instead. This will make bank loans to the general public harder to get. 

Suggested reading: Crypto Loans 2.0: YouHodler's Flagship Feature gets a Facelift

Potential security risks

Digitalized currencies are always at risk for data leaks or hacks. Central banks store CBDC payment information, making them targets for cyberattacks. Identity theft is a major concern, and banks have experienced data breaches in the past.

Countries are still developing and testing CBDCs. Hackers or other malicious actors might try to find weaknesses in the system to exploit. If countries make bad design choices, users will be at higher risk for exploitation or fraud. 

Increased deposit rates

CBDC deposits have the potential to replace traditional bank deposits. Commercial banks might increase deposit rates for CBDC as a result. 

FAQ: Will CBDC replace cryptocurrency someday?

In our opinion, no, CBDC will not replace cryptocurrency in the future. A world where both exist independently together is more liekly. Digital currency is subject to completely different legal control. Because of this, CBDC literally cannot replace cryptocurrency. Their values and purposes are too distinct. If anything, CBDCs could help cryptocurrency become more mainstream.
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The FTX exchange collapse is a symptom of several badly timed and panicked decisions. Stricter policies may have prevented bankruptcy. This policies would be in place if there were more regulation brought on from CBDC. Furthermore, governments issuing CBDCs validate the blockchain concept on the whole. This opens the doors to the technology in ways that are not possible at the moment. Just the fact that this is even being discussed right now proves that blockchain is not a fad but an incredible technology with vast potential.

How to prepare for CBDC adoption?

As just discussed, CBDC adoption could mean mass adoption for the blockchain industry on the whole. There will be investment opportunities. How do you prepare for them? Here are a few tips.

• Research: Research top projects in the industry that align with your values. Make sure they are legitimate and safe before investing in them.
• Invest: We are currently in a bear market. This provides good investment opportunities for those that want to buy at lower prices.
• Manage risk: Make sure your portfolio has a nice mix of safe, stable assets and a smaller portion of riskier but potentially more profitable ones.
• Explore new financial services: Financial services like loans, yield accounts, exchanges and trading can help you get creative with your portfolio.

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Disclaimer “The content should not be construed as investment advice and does not constitute any offer or solicitation to offer or recommendation of any investment product. It is made available to you for information and/or education purposes only.

‍You should take independent investment advice from a professional in connection with, or independently research and verify any information that you find in the article and wish to rely upon.”