A Beginners Guide to State-Issued Cryptocurrency and Central Bank Digital Currency (CBDC)

Namit Pandey Guides February 12, 2020
CBDC

A Beginners Guide to State-Issued Cryptocurrency and Central Bank Digital Currency (CBDC)

What are Cryptocurrencies?

Over the past couple of years, there has been a lot being said about “cryptocurrencies” and “blockchain” being a game-changer. But the majority of the common public today still has little to no knowledge about what these terms mean. According to Wikipedia, “A cryptocurrency is a digital asset designed to work as a medium of exchange that uses strong cryptography to

secure financial transactions, control the creation of additional units, and verify the transfer of assets”. In simpler terms, cryptocurrencies are a form of encrypted virtual currency where encryption helps provide more secure and faster transactions.

The technology on which this currency is based is called blockchain technology. Blockchain is a chain of encrypted units called blocks. These blocks store all the records of all the programs or transactions that are executed using the blockchain.

The credit for the first blockchain and cryptocurrency goes to Satoshi Nakamoto, a pseudonym for a single or a group of developers responsible for creation on Bitcoin. Bitcoin was the first cryptocurrency created and as a part of its implementation, the first blockchain was also created.

Pros And Cons of Cryptocurrencies

Ever since Bitcoin was released, there has been the release of a lot more variants of cryptocurrencies and blockchains which has led to an increasing call for these cryptocurrencies replacing the fiat currency due to the numerous advantages they offer over the existing system like:

  • Decentralized systems increase privacy and safety.
  • Decentralized systems also reduce the control of any single entity like a government or a central bank can have over the currency.
  • The transaction records made using cryptocurrency are stored in the blockchain and are immutable.
  • The transactions are quicker and much more efficient compared to traditional banking transactions.
  • Cross-border transactions are a lot easier due to lower charges and instantaneous transactions from yours to the other persons’ wallet.

However, this system also has its own set of disadvantages like:

  • The value of cryptocurrency is volatile and can be influenced very easily if a small number of people hold a large number of tokens of the currency. They can

pump-and-dump causing a crash in the value of the currency.

  • The lack of regulations in the use of currency makes it difficult to be used as a reliable currency.
  • Cryptocurrencies cannot be used as legal tender in most countries.
  • The amount of knowledge the people have about cryptocurrency is nowhere close to optimal which makes them wary of using or trading in cryptocurrencies.
  • Government policies in many countries discourage people from considering cryptocurrencies as a viable investment.
  • If the blockchain on which the cryptocurrency is implemented is deleted due to a malfunction, everything on it, including the currency, will be erased.
  • If you lose your private key, you will not be able to access your wallet and lose your cryptocurrency.

State-Issued Cryptocurrency and Central Bank Digital Currency (CBDC)

CBDC is a form of a digital currency issued by the government and is a recognized legal tender. It was initially proposed by The Bank Of England to be used in the case that for some reason, cash is no longer available.

There can be two types of CBDC- Digital form of fiat currency and State-Issued Cryptocurrency. A digital form of fiat currency is not encrypted and does not use blockchain as its underlying technology. State-Issued cryptocurrency is a form of cryptocurrency issued by the Government. It is similar to the other private cryptocurrencies available in the market.

Pros And Cons for CBDC

There are quite a few countries that are planning to adopt CBDCs. There are reports of quite a few pilot programs and some countries have already released their forms of CBDCs to the public. This concept has many advantages like:

  • CBDCs will help facilitate easier and quicker cross border transactions helping in improving the process of foreign exchange.
  • It will reduce the cost of production of money by a huge factor as maintaining and printing cash takes a lot of resources.
  • It is a great means of providing a better system of payments to unbanked individuals.
  • It creates a more stable digital payment system when compared to the ones available in the market.
  • It provides immutable transaction records making it easier for the government to track money and reducing money laundering and crime funding.
  • If the CBDC performs well in the foreign markets, it provides a boost to the countries economy and helps reduce the national debt.

However, this concept also has some major cons:

  • If people decide to hold more CBDCs, it will reduce the deposits in commercial banks.

This will, in turn, make the banks increase the interest on deposits and on the loans to maintain their margins. This will create a huge competition between banks which might result in huge losses for the banks.

  • The core principle of decentralization behind cryptocurrencies will be compromised in CBDCs. Since the issuing and distribution are controlled by the government, decentralization cannot be achieved.
  • It reduces the anonymity and freedom of transactions that other cryptocurrencies provide.

Countries Using CBDC

There are a few countries that are taking a step in this direction and are introducing their cryptocurrencies as a form of legal tender. They are:

  1. Dubai: Dubai announced in 2017 that it will be releasing a digital currency known as Emcash.This is a government-backed, official digital currency pegged to the Dinar. I was created to increase the ease of transactions in both local and foreign markets.
  2. Venezuela: Venezuela introduced the Petro, its official cryptocurrency pegged to its petroleum and other natural resources. It was introduced to help in reducing the huge amount of national debt but it was rejected worldwide and failed to make an impact on the national economy. The value of one Petro is equal to the value of one barrel of petroleum. Recently, the government of Venezuela announced that it will accept payments for petroleum products in Petro making it the official commercial currency.
  3. Senegal: Senegal released the CFA, a CBDC regulated by the Central bank of West
  4. Africa. It is majorly used in West Afican countries and holds the same value as the fiat currency CFA Franc. It is a legal tender and used as a digital version of CFA Franc.
  5. The Marshall Islands: The Marshall Islands was the first country to make cryptocurrency a legal tender. It is used as a mainstream currency along with the USD which is the official fiat currency of the island nation. This currency is called Sovereign (SOV). This step was taken to introduce a local currency and reduce the dependency on USD.
  6. Russia: Russia recently announced that it was developing its CBDC called the Cryptoruble. This Cryptoruble will be the digital form of the Ruble and will mirror its value. This currency is still in its development phase.
  7. Sweden: Sweden is also in the process of developing its form of CBDC called the E-krona. This currency is still early in its development and is being researched for the Swedish market.
  8. China: China recently announced that its process of creating a state-issued cryptocurrency is being expedited to compete with Libra, the cryptocurrency proposed by Facebook. This currency has no official name yet but it is reported to be backed by the Yuan.
  9. Tunisia: Tunisia has recently announced that they are considering different alternatives for an official cryptocurrency. They are in the early stages of development and have not yet announced any official name for the currency.
  10. Japan: Japan has released the -coin a digital currency created to increase the ease of transactions. This is just a digital form of the fiat currency, Yen and not a blockchain-based cryptocurrency.
  11. Estonia: Estonia had proposed the Estcoin, a nationalized cryptocurrency but the project was later canceled by the government.

There are a few more countries like Saudi Arabia, Singapore, etc, considering making their version of cryptocurrency which is a very promising development.

The concept of nationalized cryptocurrency is great in theory, but the results so far have not been very promising. The Marshall Islands’ SOV is the only major success providing proof of concept on a small scale.

For better results, countries need to improve the execution of their plans. They need to retain the basic core principles of cryptocurrency and find ways to ensure that the ones issued by them are accepted worldwide and not rejected as in the case of Venezuela’s Petro.

The International Monetary Fund is also assisting countries in this field. They are helping the countries with policies, pilot programs and investigating alternate payment options. Its teams are already working towards modernizing payment systems and in researching the implications of CBDCs on the international market and the country’s economy.

Views Worldwide

While many countries are showing an inclination towards CBDCs, some countries are still rigid in their views. They believe that the disadvantages and dangers of adopting digital currencies outweigh the positives. They have made it illegal to use any form of digital currency- crypto or otherwise- as a form of money. In these countries, only peer-to-peer and broker-to-peer trading is the only use for digital currencies. However, any countries are adopting the blockchain technology in their operations. The use of this technology has the potential to increase efficiency and speed of operations. The immutable and decentralized property of the blocks has inspired a lot of countries and organizations as a distributed ledger to store records of their operations.

Some countries are also planning to release payment gateways and wallets using bitcoin technology to be able to track the transactions. These systems are also increasing the transparency in organizations since anyone on the blockchain network being used, can access the records.

The Answer?

While there is still a long way to go, the recent developments are very encouraging from the consumers’ point of view. The transactions are getting faster, safer and easier, and the data is getting decentralized. But it will still be years before we achieve the perfect system, combining the best of the past with the promise of the future.

The increased use of blockchain technology across various fields like payments, social media, real estate, and currencies has the potential to pave the way for mass adoption. If the consumers gradually shift towards products and services using blockchain technology, organizations and governments too, are likely to start integrating it into their systems. For example, the thought of sending money to any part of the world by just having someone’s email id was unfathomable before PayPal came in and changed the game. Similarly Amazon, Uber, and Netflix caused seismic shifts in their respective markets.

Cryptocurrency too does have the potential and promise to impact such a change. But before we move towards a system purely based on cryptocurrencies, we need to go through a transition phase where we maintain a balance between new and conventional. To achieve that balance, state-issued cryptocurrencies may not be such a bad idea. With the right amount of regulations and freedom and the right execution, these currencies can help achieve that balance and pave the way for a more transparent and efficient banking system.

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A Beginners Guide to State-Issued Cryptocurrency and Central Bank Digital Currency (CBDC)
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A Beginners Guide to State-Issued Cryptocurrency and Central Bank Digital Currency (CBDC)
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Cryptocurrency and Central Bank Digital Currency (CBDC) is a form of a digital currency issued by the government and is a recognized legal tender. It was initially proposed by The Bank Of England to be used in the case that for some reason, cash is no longer available.
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Author: Namit Pandey
Namit is a contributing writer at chainflux.com. He has been involved in the world of cryptocurrency and blockchain since 2019 and has been active in forums, trading and writing about various topics in the crypto world.
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Namit Pandey 1 Article
Namit is a contributing writer at chainflux.com. He has been involved in the world of cryptocurrency and blockchain since 2019 and has been active in forums, trading and writing about various topics in the crypto world.
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