Central Bank Digital Currency

The crypto market is becoming more mature and is also gaining traction. Payments and transactions today are increasingly done with digital money instead of fiat money. More and more national governments are developing their own national currency into a digital currency. As is the case with the euro. What exactly is a Central Bank Digital Currency (CBDC) and what impact does the CBDC have on the crypto market?

What is a CBDC?

A CBDC is nothing more than a digital version of fiat money. Like a digital version of the dollar or the euro. More and more governments are seeing the success of the crypto market and thus as a direct competitor to their own national currencies. El Salvador is the first country where you have the bitcoin as a 'legal tender'. So you can pay with bitcoin inside the Salvadorian economy. Because crypto can be a danger to their own national currency, many countries are developing their own CBDC. In this way, countries are trying to regain control over their monetary policy.

National monetary authority

Blockchain technology actually originated as an anti-movement to the current monetary system. Banks, governments and third parties actually decide how we conduct our financial affairs. Citizens feel constrained by this. Since crypto and blockchain became more and more well known, more and more investors found their way to crypto. This was due to the decentralized nature of blockchain. Blockchain is not centrally controlled like a bank and a government. The blockchain is controlled decentrally. That is, the network (all the participants in the network) determine what should happen. This gives the participants complete control over what should happen. There is no longer a central party that makes promises and decisions for them. In response, governments are exploring ways to take back control through CBDCs.

Banks and financial institutions are sounding the alarm. They see a major threat in crypto and blockchain. They fear that they will lose their monetary authority if crypto becomes the norm in a country. This is also mainly due to the fact that banks offer very low (or even negative) interest rates. This is no longer interesting for people to deposit their money in a bank. 

Impact of CBDC on crypto?

The birth of CBDC is due to crypto. But it is worth noting that CBDC and crypto are completely different. Crypto like bitcoin is completely decentralized and is autonomous. So bitcoin is not regulated by a central authority. This is good to remember because crypto operates entirely on a blockchain while a CBDC is not. Given the fact that Bitcoin is increasingly taking shape as a legal tender, such as in El Salvador, CBDCs and Bitcoin can be seen as each other's competitors.

Another major difference between a CBDC and crypto is scarcity. There are only 21 million bitcoin available. After 21 million bitcoin are mined, no more bitcoin can be created. So scarcity is created. Notice well that not all crypto have a limit. Dogecoin, for example, can be created infinitely.

Using a CBDC could also lower the barrier to entry into the crypto market. How does this work? If more and more people use CBDC, it will be easier to make the switch to crypto because users are familiar with digital money. People will therefore be used to using a wallet where they can store CBDCs. Indeed, this is also necessary to store crypto securely.

It is not surprising that governments are now finding a way to compete with crypto. This is a message to the crypto world. This message is: blockchain and crypto is such a threat that we want to do something about it. This indirectly means that governments do not underestimate the value of crypto and recognize that it is a technology that has a future. Governments will not and cannot sit back and do nothing.

Pros and cons of CBDC
Pros:

• Errors happen regularly in processing payments and or transactions. One example is the wrongful payment of benefits. By defining the conditions in code, you can prevent the risk of incorrect payments. For example, only payments that meet certain conditions are met. Since the law is not black and white, a fellow employee must always be ready to judge certain situations on their own merits.
• In the current system, there are many middlemen present. This makes processing transactions time consuming. CBDCs in combination with blockchain can facilitate this process. By using blockchain, transactions between banks can become more efficient.
• More and more payments are being made digitally. Cash payments are becoming less common. Certainly due to the corona crisis and lockdowns, digital payments have increased. Illegal activities are also mainly financed with cash. By using a CBDC, illegal activities can largely disappear. This is because blockchain is transparent and every transaction can be traced on the blockchain. Combined with a CBDC (a central authority that has insight into the blockchain), illegal activities can be detected and prevented.

Cons

• As you already know, CBDCs greatly detract from the decentralized nature of blockchain. This is because a CBDC is entirely managed by an authority. Also, sensitive information is kept in 1 location. Blockchain, on the other hand, is decentralized and all transactions are on the computer of all participants. So every participant in the blockchain has all the transactions of the blockchain. If one participant is hacked, then other participants can continue with the correct blockchain. If a participant is hacked, it does not affect the functioning of the blockchain. This is obviously different if an authority is in charge. If this authority is hacked, then all personal information is in the hands of a party that can abuse it.
• The biggest disadvantage of the CBDC is privacy. So this CBDC is centralized. This central authority collects all the information of you as a person. Not only what transactions you make, but also how much money you send, to whom and when. A whole network is exposed that can affect your integrity and privacy. For example, consider that this authority may prohibit you from making certain transactions to individuals. I can imagine that with criminals and people on the sanctions list, that would be desirable.

• Governments using CBDCs can deny, block and close individual accounts to make transactions impossible. One example is that China can make the purchase of bitcoin impossible by only offering CBDCs.

• CBDCs allow governments to control everything. These governments can hand out sanctions and direct behavior of citizens. This can be dangerous for regimes that are known for oppressing their own people or do not hold human rights in high regard.