What is a central bank digital currency (CBDC) and how does it work?

What is a central bank digital currency (CBDC) and how does it work?

Similarly, the Chinese central bank has also announced a digital currency project. In this context, it is interesting to learn how different will be the central bank digital currency from their commercial cousins – virtual currencies and crypto currencies.

Digital money, which was formerly exclusive to the computer sector, is increasingly making its way into central bank realms. Under the ‘e-krona’ initiative, the Swedish Riks Bank revealed plans to introduce a central bank digital currency. The Swedish currency is the krona. The significance of the development is that Sweden will receive a central bank-issued digital money that is an identical replica of its physical currency. The digital money will vary from the actual krona only in appearance and transfer. The value will remain the same, and the e-Krona will be accepted as legal money.

What is central bank digital currency?

The Basel based Bank for International Settlement which is doing pioneering and authoritative research works in central banking appointed a Committee on Central Bank digital currencies (2018). The Committee in its report observed that it is not easy to define CBDC. “CBDC is not a well-defined term. It is used to refer to a number of concepts.” – the BIS Committee on CBDC.

One fact about CBCD is that central banks across the world already provides digital money to commercial banks and other financial institutions in the form of reserves or settlement of balances. This means that when a bank is having higher reserves with the Reserve Bank of India, it gets a that much money in the form of CBCD.

Still, this money is provided to big financial entities or what we can say wholesalers. On the other hand, the digital money that the general public is obtaining in the form of virtual currencies and crypto currencies from different tech players are not from the central banks. Effectively central banks do not provide retail digital money for public use. It is this retail digital money that we are speaking about and that is in our imagination.

Mixing of the already existing reserves and settlements to banks (which we can say are examples of CBDC) and the proposed retail money to be issued (like e-Krona) to the public, necessitates a careful definition of CBDC. The BIS highlights that ‘a CBDC is a digital form of central bank money that is different from balances in traditional reserve or settlement accounts.’

We can define that ‘CBDC is a digital payment device which is issued and fully backed by a central bank and is legal tender.’

Central Bank Digital Currency is also called digital fiat currency or digital base money. CBDC is a new form of digital central bank money that is different from reserves or settlement balances held by commercial banks at central banks. This is point we already discussed when we mentioned that CBDC is for public (general) use and not for just wholesale (banks) use.

The opinion of the BIS that CBDC is a concept as it can have different features and versions, necessitates us to get lot more knowledge on the various specifications of CBDC.

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