CBDCs, or Central Bank Digital Currencies as they are called, are virtual currencies that are issued by the central bank of a country. Unlike Crypto Currencies, they are regulated by the government, and just like physical cash, they are allowed to be used as legal tender for transactions. The considerable attention that it has gained in the current times is because of the increasing concerns about economic stability as well as the popularity of digital payment methods, though the concept has been around for several years.

With the potential to bring ease to the ways we do transactions and manage our finances, CBDCs offer a safe and convenient alternative to traditional physical currencies. Conditional to the design selected by the respective central banks, CBDCs can take diverse forms. They are also essentially regulated by the government, which makes them distinct from other decentralized digital currencies, which are not issued and controlled by a central authority.

The thought and model of digital currencies have existed for several decades now. According to blazingbot.com – in 1990, an American cryptographer, David Chaum, created the first digital currency, but due to the lack of regulations, it was not adopted. In the early 2000s, prepaid cards and e-money gained popularity as a form of digital payment, which was usually issued by private companies without having the central banks involved, but the idea came into the limelight with the emergence of Bitcoin in the year 2009. Since then, the market has seen the spread of different kinds of cryptocurrencies.

Due to the challenges caused by traditional flat currencies, such as inefficient international transactions and counterfeiting, digital currencies are seen as a potential solution not only to these issues but also to increase economic inclusion and transparency in the financial system. Although still in the early years of development, various central banks around the world are taking notice and exploring the likelihood of issuing digital currencies of their own. One such example is Sweden’s central bank, which, in 2014, started to consider issuing its own digital currency known as the e-krona. This was followed by the central banks in Canada and China too.

However, other such attempts by countries such as Ecuador in 2014 and Venezuela in 2018 have faced challenges, and their respective CBDCs failed to be adopted widely. The evolving concept of digital currencies has made the potential adoption of CBDCs possible, and more so with the involvement of central banks. To explain the concept more precisely, there are two main types of CBDCs discussed below:

• Wholesale CBDCs: They are for the exclusive use of the financial institutions, i.e., banks, in order to assist high value and volume of transactions among themselves. Such transactions are settled simultaneously, proving a faster and more efficient alternative to the traditional interbank method of transactions.
• Retail CBDCs: As the name suggests, this type of centralized digital currency is for the general public and can be used in their day-to-day transactions. This provides a digital equivalent to physical cash that allows individuals to access their money in the central banks without intermediaries, such as commercial banks.

Similar to cryptocurrencies, CBDCs also use blockchain technology as their technical structure, which primarily serves as a digital ledger and records all transactions securely and transparently. But unlike cryptocurrencies, the presence of a central authority in the case of CBDCs mainly ensures the stability of currency and regulation of all the financial activities, which not only results in the overseeing of its issuance and distribution but also strict protocols, preventing unauthorized access to keep the user’s data safe. Improvement in the implementation of monetary policy is another advantage of CBDCs, which is somehow a tough task in the case of physical cash, which can be difficult to track and disrupts the effective management of money supply and interest rates. Focus on strong privacy and security is another key feature of CBDCs, and since the transactions are encrypted due to the usage of blockchain technology, sensitive information stays clear of the reach of hackers. Additionally, individuals who may not have access to traditional banking services and remain unbanked or under-banked can easily be provided access to digital payment systems, making CBDCs a financially inclusive alternative.

Despite the advantages, there are concerns associated with CBDCs. One of these concerns is its vulnerability to cyber-attacks and hacking, which can not only result in unauthorized access and theft of funds but also in the disruption of the entire financial system. But such risks could always be fought off with robust security measures including but not limited to secure communication protocols, encryption techniques, and digital signatures. Another concern is its impact on the traditional banking and financial systems, which could primarily undermine the role of commercial banks. This can result in a decrease in deposits and lending activities, which would have far-reaching consequences for the economy.

Another major hurdle for the CBDCs is to navigate through the regulations and legalities. The absence of legislation on their use could create an uncertain environment for its users and the overall financial sector. Key issues such as to prevent money-laundering, which is largely associated with corruption and terror financing, ensuring consumer protection, and overseeing cross-border transactions needs to be primarily addressed.

Overall, the idea of CBDCs is still new and has caused both excitement and skepticism, but it is obvious that despite the limitations, it can potentially change the ways we think about money and transactions. Public adoption is still a concern, but it would largely depend on government policies and technological advancements. With reference to the global economy, it could also level the field for financially unstable regions and grant them with stability in times of crisis. It is only the future that will tell how CBDCs will shape the global economic and financial system, but given the mass potential, it would be fascinating to see how governments and central banks will succeed in keeping an open mind and finding ways to overcome the limitations. The possibilities are, indeed, endless.