What’s the difference between a central bank digital currency and a cryptocurrency?
If you’re dazed and confused by the talk of cryptocurrency here and central bank digital currency there, then read on for some clarity.
CBDCs, or Central Bank Digital Currencies, are a new type of digital currency being developed by central banks around the world, including the European Central Bank and the Federal Reserve. Cryptocurrencies, on the other hand, are decentralized digital currencies that are not subject to government control.
CBDCs are similar to cryptocurrencies in that they are digital and can be used for peer-to-peer transactions. However, CBDCs differ from cryptocurrencies in that they are issued by central banks and regulated by national governments. Cryptocurrencies, on the other hand, are not regulated by any central authority.
As a result, CBDCs are sometimes seen as a more viable option for global payments than cryptocurrencies while others argue that CBDCs put too much control over finances in the hands of governments and could lead to yet more surveillance.
How do CBDCs and cryptocurrencies work?
CBDCs, or Central Bank Digital Currencies, are fiat currencies like the US dollar or the Euro in digital form. Cryptocurrencies, on the other hand, are digital assets that use cryptography to secure transactions and control the creation of new units. So, what’s the difference between CBDCs and cryptocurrencies?
- CBDCs are issued by central banks, while cryptocurrencies are decentralized. That means there’s no one central authority controlling the supply of Bitcoin, Ethereum, Solana, etc.
- A cryptocurrency can be be more volatile than a central bank digital currency. While the value of a central bank digital currency is pegged to its underlying fiat currency, the price of a cryptocurrency can fluctuate wildly.
- CBDCs are designed to be used as a medium of exchange, while many cryptocurrencies are intended to be used as investments, as well as paying for goods and services via digital payments.
Of course, there are exceptions to every rule, but these are some of the key differences between CBDCs and cryptocurrencies.
Are there any benefits of CBDCs over cryptocurrencies?
Governments argue that CBDCs are preferable for several reasons, but as we shall see, though they may seem to deliver security and convenience, they may have another, less friendly purpose.
- CBDCs are backed by a central bank, which gives them more stability than cryptocurrencies, which can be subject to wild fluctuations in value.
- CBDCs can be used to make payments directly between two parties, without the need for a third-party processor. This makes transactions faster and more efficient.
- CBDCs are designed to be easily integrated into existing payment systems, making them more user-friendly than cryptocurrencies.
These advantages are used to persuade people to adopt and accept CBDCs, and sure enough, CBDCs are starting to gain traction as a viable alternative to cryptocurrencies.
The risks associated with CBDCs and cryptocurrencies
Risks associated with cryptocurrencies
Cryptocurrencies are digital or virtual tokens that use cryptography to secure their transactions and to control the creation of new units. Bitcoin, the best-known cryptocurrency, was created in 2009. The rising price of Bitcoin over the years sinces has created some multi-millionaires (and a few very frustrated individuals who lost their wallet passphrases during those early years).
Cryptocurrencies are often more volatile than traditional fiat currencies, and if the blockchain network isn’t they’re also vulnerable to hacking and fraud. How vulnerable they are depends on the strength and security of the network on which they operate, and it is the resilience and strength of the blockchain network that helps push up the price of the currency.
Another risk to consider is that cryptocurrencies are not regulated by any government or financial institution, which means they offer little in the way of consumer protection if something goes wrong. Finally, there is always the possibility that the cryptocurrency you’ve invested in could simply disappear, as there is no guarantee that it will continue to be traded on exchanges or accepted by merchants.
Risks associated with CBDCs
CBDCs, on the other hand, could potentially be used to track people’s individual purchases, movements, and spending patterns. For example, if central banks require commercial banks to convert customers’ deposits into CBDCs, this could give rise to customer data being shared with the central bank. In addition, the use of blockchain technology to record CBDC transactions could also result in personal data being stored on a distributed ledger, which could be accessible to a wide range of parties.
Another risk relates to the way in which CBDCs are distributed. If central banks distribute CBDCs through commercial banks, there is a risk that individuals’ financial information could be exposed. For example, if an individual withdrew cash from a commercial bank in order to purchase a good or service with a CBDC, the commercial bank would know both the value of the transaction and the recipient’s wallet address. This information could then be used to generate detailed profiles of individuals’ spending habits.
Also, it is worth noting that the use of CBDCs could have implications for monetary policy. For instance, if central banks were to providing direct funding to households through distributing CBDCs, this could reduce the effectiveness of monetary policy tools such as interest rates.
Finally, there is the more sinister aspect of CBDCs. Some argue that governments will use their powers for a variety of draconian policies. For example:
- Financial restrictions on travel due to insufficient ‘carbon credits’
- Financial penalties for ‘wrongthink’
- Financial penalties for ‘hate speech’
- Financial penalties for any kind of online activity deemed socially undesireable
The best-known CBDC is China’s Digital Yuan, which is being tested in several cities. The fact that it’s being tested by the CCP in China is, for some, enough evidence that this as another form of surveillance and that it’s be used to control the population.
The future of CBDCs and cryptocurrencies
What does the future hold for these digital assets? Cryptocurrencies are still largely considered to be a speculative investment, and their volatile nature means that they’re unlikely to be widely adopted as a currency any time soon. However, the underlying blockchain technology has enormous potential, and it’s possible that cryptocurrencies could play a major role in the future of finance.
CBDCs, on the other hand, are seen as a more serious proposition. Central banks are already experimenting with issuing digital versions of their currencies, and it’s only a matter of time before one of them is launched on a wider scale. While CBDCs are unlikely to replace cash entirely, they could have a significant impact on the way we make payments in the future. So, what does the future hold for cryptocurrencies and CBDCs? Only time will tell.
In summary
Central banks are considering issuing CBDCs for several reasons, including to increase financial inclusion, reduce the costs of processing payments, and to provide the public with an alternative to privately issued digital currencies. Many central banks are also investigating how CBDCs could be used to help implement monetary and fiscal policy.
However, there are also risks associated with issuing CBDCs, including the potential for money laundering and financial instability. As a result, central banks are proceeding carefully with their plans to issue CBDCs. The European Central Bank, for example, has said that it will not issue a euro-denominated CBDC until it has assessed all of the risks and benefits. Similarly, the Bank of Canada has said that it is not planning to issue a Canadian dollar-denominated CBDC in the near future. Ultimately, whether or not to issue a CBDC is a decision that each central bank will make based on its unique circumstances.
So, what’s the verdict? Are CBDCs and cryptocurrencies a passing fad or will they revolutionize how we do business? The answer is, as with most things in life, it’s complicated. There are definite benefits to using CBDCs over cryptocurrencies, but there are also risks associated with them. It seems likely that both will continue to be used for some time, but which one eventually comes out on top remains to be seen. In the meantime, it can’t hurt to familiarize yourself with both of these innovative technologies so you can make an informed decision about whether or not to use them in your own business dealings.
