How Central Bank Digital Currencies(CBDC) Work

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What Is a Central Bank Digital Currency (CBDC)?


A central bank digital currency (CBDC) makes use of an electronic record or digitized token to define the virtual version of the sovereign currency of a specified nation or region. A CBDC, being centralized, is issued and regulated by the proficient financial authority of the country.

Understanding Central Bank Digital Currencies(CBDCs)


The passing years have witnessed scaling interest in cryptocurrencies like Bitcoin and Ethereum. These work on distributed ledger technology better known as Blockchain Technology. These virtual currencies have gained immense traction in the trading arena owing to their decentralized and regulation-free nature. Some view their rise as a potent threat to the traditional banking system that functions under the strict guidelines of the country’s regulatory authority.

There is little to no clarity regarding any suitable maintenance backing up the valuations of cryptocurrencies. Moreover, the iterative launch of new cryptocurrencies has added to the concerns about the chances of scams, thefts, and hacks.

Attempts to control the popularity and growth of such cryptocurrencies have met with failure. This has led the top central banks across the globe to work on or ponder over the introduction of their own versions of cryptocurrencies. These regulated cryptocurrencies are called central bank digital currencies are going to be enforced by financial authorities of respective countries.

Every CBDC unit is set to act as a secure digital instrument, an equivalent of paper currency fit to be used as a mode of payment, has a store of value, and a recognized official unit of account. Just as paper-based currency note bears a unique serial number, so shall a CBDC unit - in order to be distinctive enough to prevent counterfeiting. As this is to be issued by and controlled by the central bank, it will function alongside other formats of regulated money like coins, bills, notes, and bonds. CBDC aims at bringing the best of both worlds - the ease and security of the digitized version like the crypto and the regulated and sovereign-backed feature worthy of any instrument issued by the traditional banking system. The specific central bank remains solely responsible for its circulation and operation.

Examples of CBDCs


No state has officially introduced a central bank-backed digital currency, yet. Many have, however, launched pilot projects to determine the viability and usability of the CBDC.

The Bank of England (BOE) pioneered the initiative of the CBDC proposition. This led to the central banks of other nations, for example, People’s Bank of China (PBoC), Bank of Canada (BoC), and central banks of Uruguay, Thailand, Venezuela, Sweden, and Singapore, to probe into the possible launch of a central bank-issued digital currency.

Russia has channeled energies into the creation of the “crypto-ruble” as announced by Vladimir Putin in 2017.

Venezuela has supposedly been working on a similar model termed “petro” since the same year. The Venezuelan government has also announced the launch of “petro gold” in the following year, allegedly pegging the crypto to the value of oil, gold, and other resources.

Traditional Banking System

CBDC Payments System

Why Blockchain and Ethereum for CBDC


The use of Blockchain technology to CBDC brings along a plethora of unique advantages. Ethereum, specifically is the most production-ready blockchain available to support the CBDC requirements with regards to scalability and privacy.

System Trust

A blockchain-powered CBDC empowers central banks to control the currency and protect the privacy and independence of the CBDC usage. It is critical that users are not locked in by intermediaries and sufficient trust is fostered so that the people may use it.

Programmability

CBDC rules may be hard-coded in the protocol to enforce its compliance, i.e wallet thresholds or third-party access to the system.

Data Availability

Distributed systems like the blockchain natively grant data availability and resilience, in addition to trust and transparency regarding transaction procedures. In view of this, Ethereum’s capacity to support large networks (~10k+ nodes and thousands of users) is proven.

Innovation

A Blockchain - fuelled CBDC derives benefits from the innovative products and services that are available across the open-source blockchain ecosystem. This includes non-custodial wallets, zero-knowledge cryptography, and decentralized finance. Ethereum is considered the largest blockchain ecosystem in the world with over 350,000 developers.
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