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Central Bank Digital Currency (CBDC) refers to digital tokens, same as cryptocurrency, that have been issued by a central bank. CBDC can also be seen as an electronic version of a country’s fiat currency that can be used to make digital payments. A CBDC is a digital currency that is universally accessible. Central bank digital currencies are pegged to the value of issuing a country’s fiat currency and regulated by a country’s monetary authority or central bank.
Fiat money is not backed by a physical commodity such as gold or silver and it thus serves as a form of legal tender to exchange goods and services. Initially, fiat money used to come in the form of coins and banknotes. However, at the current time with the help of technological development governments as well as financial institutions have begun supplementing fiat money with a credit-based model, wherein balances and transactions are digitally recorded.
Though physical currency, which is a traditional mode of payment, is still widely accepted;, there has been a significant decline in its use, especially after the Coronavirus outbreak. On top of this, the evolution of cryptocurrency along with blockchain technology has resulted in more preference for cashless societies and digital currencies. Hence, governments as well as central banks across the world are identifying new possibilities for using government-backed digital currencies. If this happens, then just like fiat money these currencies will be fully supported by the government issuing them.
CBDCs are of two types – Wholesale and Retail. Wholesale CBDCs are mainly used by financial institutions like banks. On the other hand, retail CBDCs are used by consumers & businesses, much like traditional money.
It is believed that CBDCs would also bring down the risks of using digital currencies in their present form. As we know Cryptocurrencies are extremely volatile as their value is continuously fluctuating. There are apprehensions that the volatility in the crypto market could result in severe financial loss to individuals thus affecting the overall economy. If Central bank digital currencies get full backing from the issuing government and the monetary authority, they would provide people with a regular means of exchanging virtual currency.
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