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The progress in the field of Information Technology and its benefits to the financial sector have encouraged quite a few central banks and academics to reflect on the benefits of Central Bank Digital Currencies (CBDC) open to the general public.

Introduction to CBDC

For the purpose of reflecting the digital form of a fiat currency of a particular nation (or region), a Central Bank Digital Currency (CBDC) uses a blockchain-based token. A CBDC is centralized, meaning that it is mainly issued by the country’s competent monetary authority and controlled by it as well.

Traditional banking regulatory authorities all over the world had been seen struggling over the past few years for the purpose of regulating the continuously increasing impact of the most common cryptocurrencies such as Bitcoin and Ethereum which are mainly running on a blockchain network. Due to their decentralized and regulatory-free existence, such virtual currencies have gained more than enough popularity and have become quite a challenging task to the present-day conventional banking structure that is habitual of functioning under the supervision and control of a country’s regulatory authority, a central bank is the best example.

Understanding Central Bank Digital Currency (CBDC)

In order to back up the valuations of cryptocurrencies, there is no such clarification on any reasonable and proper reserve management. In addition to this, the ongoing introduction of all these new cryptocurrencies has also sparked a lot of major concerns about the potential for scams, robberies, and hacks. Most of the leading central banks around the world are currently working on or thinking of launching their own absolutely new versions of cryptocurrencies, because of the reason that they are still unable to monitor the development and effect of such cryptocurrencies.

These controlled cryptocurrencies are referred to as Central Bank Digital Currencies and will be run by a specific country’s respective monetary authorities or central banks in their own way. Each unit of the CBDC will be acting just like a safe digital instrument quite similar to a paper bill and is capable of being used as a payment system, a value store, and an official account unit as well. Each CBDC unit will also be distinguishable for the purpose of preventing imitation, much like a paper-based currency note that carries a unique serial number of its own.
It will be operating alongside other different types of regulated currency, such as coins, bills, notes, and bonds, since it will be a part of the money supply managed by the central bank. CBDC is currently seeking to put the convenience and security of all these digital forms such as cryptocurrencies and the conventional banking systems limited, reserved-backed money circulation into the best of both worlds. The country’s own central bank or other competent monetary authority will be totally responsible for all of its operations.

Uses of CBDC

For all the retail and wholesale payments, CBDC can be built quite easily. However, a retail CBDC mainly refers to a digital version of currency, a wholesale CBDC gives a brief idea about modern interbank settlement infrastructure. Central banks that have been testing the CBDC have concentrated a lot more on quick, low-cost payments in particular.

Retail CBDC

Retail CBDC, quite similar to the digital bank notes, is mainly used for the payments between individuals and corporations or with other individuals. The retail CBDC’s daily amount is usually no less than 100,000,000 transactions.

Wholesale CBDC

Wholesale CBDC will be used for the interbank settlement facilitation, i.e. Payments between all those banks that are having Central Bank accounts and few other bodies. The daily CBDC wholesale volume is typically no more than 100,000 transactions.

Benefits of CBDC

The financial system of all the central banks is currently facing a large number of problems, ranging from expensive payment settlements to a sudden decline in the use of different bank notes and a shortage of financial access for all those people who are far from bank branches. The cross-border payment processes these days mostly include moving assets and confidential transaction data via several correspondent banks, exposing settlement and operational risk to different organizations and individuals.
By simplifying the development of a more stable payment system that is mainly acting as a large-scale decentralized clearing house and asset registry, the blockchain-based CBDC addresses the inefficiencies and weaknesses in our current central banking infrastructure.

Benefits of Retail CBDC

On mobile devices, digital currency can easily be circulated, increasing access and usability for all those people who are far from bank branches and are having no access to physical money. A CBDC is virtually quite digital and does not require any kind of expensive and time-consuming reconciliation that e-commerce and few other cross-border payments currently require.
The platform-based software model of CBDC nullifies almost all the barriers to entry for almost all the new companies in the payments industry, fosters competition and creativity, and drives financial institutions towards service globalization. CBDC permits the central banks direct power over the supply of currency, simplifies its distribution to the individuals of government benefits and enhances the control over tax control transactions.

Benefits of Wholesale CBDC

CBDC allows the central banks direct control over money supply, simplifying CBDC payments are pretty quickly settled between counterparties on the order basis of a single individual through automation and decentralized netting solutions, reducing the risk of overnight batch processing and collateralization to a large extent. By allowing payment-versus-payment settlement for payments in various different currencies, CBDC reduces the credit risk in cross-border payment transactions.
There will be a higher demand for tokenized payments as more tokenized asset markets grow. For the purpose of further accelerating the revolution in digital assets, CBDC offers a large-scale, decentralized clearing house and asset registry. CBDC enables end-users to get advantage from simplified banking infrastructure and through the broader use of stable coin technology, ensures that central banks retain a key role in interbank settlements.

CBDC’s Effect on Commercial Banks

The first strand of the literature asks how commercial banks will be impacted by CBDC. Basically, the CBDC will be acting as an interest-bearing replacement for the deposits of those commercial banks. In the face of such a substitution, commercial banks will start to react by adjusting the deposit rates they’re already giving to savers and, owing to the resulting effect on the cost of financing banks, the terms of the loans they offer to borrowers.
As a result of this, with the implementation of a CBDC, both the quantity of bank deposits and the amount of bank-intermediated lending may change. In this regard, this strand of literature may also raise some policymakers’ concern that the implementation of the CBDC may be able to replace the main source of financing for banks and cause commercial banks to be disintermediated, which in turn may lead to a reduction in their lending.

Since CBDC tends to induce more favorable contractual conditions for its depositors, a significant consequence is that it may increase the demand for deposits, both through an extreme margin (existing depositors are highly encouraged to save a lot more) and a wide margin (individuals who would otherwise prefer to be unbanked are strongly recommended to pay the cost of entering the banking sector). This competitive pressure exerted by CBDC could therefore possibly end up expanding the depositor base of the banks.
Effect of CBDC on Monetary Policy and Financial Stability

The second strand of the literature surely asks about the impact of a CBDC on monetary policy and financial stability, as well as the repercussions for welfare, would be. As a new kind of central bank currency, the CBDC has got all the potential to influence the broader policy goals of central banks, but it’ll be up to them whether these banks start by serving as a new monetary policy tool or by influencing household portfolio choices and the possibility of bank runs.

The implementation of the CBDC as an alternative means of payment for bank deposits but immune from the possibility of bank runs (as the central bank does not is not allowed to carry out from banks) in times of stress and reallocating them to the CBDC if the financial conditions of banks are some kind of private information to each bank and all of its depositors. We find that most of the projects are mainly focused on the drivers of CBDC development digitized and creative economies. On the other hand, the informal economy is quite greater, Retail CBDC work is a lot more advanced. None of the surveyed projects attempt to substitute cash – all strive to provide a digital complement.

The central bank may then start deducing the financial conditions of the banks by witnessing a quite massive and unexpected inflow of funds into its digital currency which is quite astonishing. In times of stress, this knowledge may prove to be quite critical in the development of an acceptable policy response, the quicker response will surely be needed in order to be successful. The central bank can more easily assess the state of the financial system and react a lot more efficiently by selecting the interest rate on CBDC appropriately to make it a bit more appealing in the times of stress.

CBDC-Building Together the Future of Money

There is only one thing has been made clear over the past few months and it is that CBDCs are no longer a possibility, and governments around the world are now actively governing the development of these currencies. We would definitely be able to see some of these currencies in circulation over the next few years. There are so many countries that are experimenting with the notion of state-backed digital currencies with the pandemic moving the bulk of vital services online.

The international debate about the Central Bank Digital Currency (CBDC) is gaining more and more traction. And as a result of it, CBDC initiatives from different parts of the world, aimed at digitalizing all of their payments, promoting financial inclusion, enhancing cross-border payments, promoting fiscal transfer, etc., have almost struck the globe Some industry experts are saying that Central Bank Digital Currencies are coming, and the major and important picture seems missing for everyone in denial mood.