Booming demand for crypto drove up the popularity for digital investments in general and there’s has since been a lot of talk about a new form of digital currency coming up known as Central Bank Digital Currency, or CBDC. Image Credit: Shutterstock

Dubai: The UAE initiated its first ever cross-border payment using ‘Digital Dirham’ on Monday. The historic milestone is a part of a wider push towards using the digital form of national currencies issued by central banks worldwide. Here’s what it means for your money and the global economy as a well.

“Booming demand for crypto drove up the popularity for digital investments in general and there’s has since been a lot of talk about a new form of digital currency coming up known as Central Bank Digital Currency, or CBDC,” explained Brian Deshell, a UAE-based cryptocurrency trader and analyst.

“CBDCs are similar to cryptocurrencies, except that their value is fixed by the central bank and equivalent to the country's national currency. While a new form of electronic money, unlike cryptocurrencies, they are issued by central banks of countries.”

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What are central bank-issued digital currencies or CBDCs?
These central bank-issued digital currencies are simply digital tokens, similar to cryptocurrency, pegged to the value of a country's currency. But they are not a form of cryptocurrency.

CBDCs are not cryptocurrencies

“Although the idea for CBDCs came from cryptocurrencies, they are two very different types of digital currencies. The key difference between CBDCs and cryptocurrency is centralisation,” explained Brody Dunn, an investment manager at a UAE-based asset advisory firm.

“Centralisation is simply the control of an activity under a single authority. A cryptocurrency is a decentralised digital currency, meaning there's no central party that controls it. With CBDCs, the central control of authority lies with the issuing country’s central bank.”

CBDCs are by definition most similar to what is known as Stablecoins, which are cryptocurrencies that are pegged to fiat money and attempt to maintain the same value. The main difference is that the world's governments issue CBDCs, while Stablecoins are issued privately.


What is the difference between cryptocurrencies and CBDCs?
Cryptocurrency transactions are processed and recorded on a block chain, which is a publicly distributed ledger. As the name implies, a central bank digital currency is controlled by a central bank.

CBDC is managed on a digital ledger (which can be a block chain or not), expediting and increasing the security of payments between banks, institutions, and individuals.

In case of cryptocurrency, transactions are sent and received through wallet addresses, and it's possible to retain some degree of anonymity. Certain types of cryptocurrency are even thought to be untraceable. With a CBDC, the central bank will have a record of users and their transactions.

110 countries and counting

110 countries around the world are researching or developing CBDCs, and they're at various stages of the process. As of June 2023, 11 countries adopted a CBDC, with an additional 53 being in advanced planning stages and 46 researching the topic, according to e-research platform Statista.

In 2020, a group of seven central banks including the US, Europe, Japan, Switzerland, Canada, Sweden, and England, indicated an intention to assess the feasibility of implementing publicly available CBDCs. The most recent addition to the countries issuing a CDBC is Jamaica.

Other countries are beginning to implement CBDCs including China and Russia as well as a host of smaller nations including South Africa, Uruguay, Barbados, Switzerland, Thailand and Iran. In 2022, the UAE became the latest regulator to express an interest in issuing a CBDC.


Why do we need CBDC?
The driving forces for CBDCs are the challenge presented to national currencies by crypto, and the uncertainty about future currency stability in general. This is because the US dollar has been losing its exclusive position as the peg for other currencies and for conducting international trade.

The public reasoning is often more guarded. Centralised oversight of the movement of currency could put an end to a lot of fraud. Identifiable digital currency is also hard to steal. Moreover, a currency that can move without sorting banks and clearing houses involves far lower costs, especially for corporations that conduct thousands of transactions per day.

Since CBDCs could affect the crypto market, understanding them is important if you're investing in cryptocurrency.

How does a CBDC work?

So a central bank digital currency (CBDC) is essentially an electronic form of cash that can be exchanged much like you exchange traditional ‘money’. We already exchange digital money on a daily basis, whether via bank transfer, digital wallets or card payments, but there is a difference.

“Most digital payments are essentially checks – instructions for a bank to pay ‘real’ money from your account. As such, multiple actors are involved to enact the transactions, clearing payments and administering millions of individual accounts,” added Dunn.

“A CBDC on the other hand, has evolved from decentralised digital currencies like Bitcoin and Ethereum and is more like cash itself in cutting out the middlemen – it seemingly travels directly from person to person or from customer to vendor like a coin.”

Although the idea for CBDCs came from cryptocurrencies, they are two very different types of digital currencie

- Brody Dunn

CBDCs need central databases

Deshell further explained that both cryptocurrencies and CBDC are dependent on networked electronic resources to create, track and validate transactions. “In the case of most cryptocurrencies, such as Bitcoin, those resources are distributed and anonymised,” he added.

“In the case of CBDC, a central database ultimately controlled by a central bank issues the currency and provides every e-currency with a unique serial number to identify it. Usually, central banks will also peg the electronic currency to their existing national currency.”

Since national currencies today are ‘fiat’, CBDCs are alternatively called digital fiat currencies. Fiat money is a type of money that is not backed by any commodity such as gold or silver, and typically declared by a decree from the government to be legal tender.

How can you benefit from CBDCs?
“Central bank money is the safest form of money available. A CBDC could also lead to transactions that are much faster, cheaper, which benefits everyone involved,” added Dunn. In countries that create retail CBDCs, consumers can get direct access to central bank funds.

“When it comes to benefits, a CBDC can be classified into two - 'Retail' CBDC, would be used like a digital extension of cash by all people and companies, and a 'Wholesale' CBDC, which could be used only by permitted institutions as a settlement asset in the interbank market.”

Retail CBDCs are issued to the general public, he further explained. Under this model, consumers are able to own a CBDC in a wallet or account and use it for payments. This type of CBDC would serve as a public digital banking option that anyone can use.

Can CBDCs be the future of money?

According to analysts at global accounting giant PricewaterhouseCoopers (PwC), "it is highly probable that the future of money will be a mix of centralised, decentralised, account-based and token-based with CBDCs, stablecoins and crypto currencies co-existing alongside traditional digital and physical currencies".

Deshell too opined that CBDC could be the future of payments. “It will be interesting to see how the market evolves as more central banks begin to explore and adopt this technology. It has the potential to revolutionise the financial world by providing a digital currency that is more efficient, secure and transparent.

“As a digital form of a country's fiat currency regulated by the country's central bank, they will be benefitted by being powered by a technology that allows central banks to channel government payments directly to households. So they not only potentially benefit governments and economies, they offer everyone involved a safe and low-cost alternative to cash.”

Key takeaways

1. A CBDC is essentially a legal currency issued by a bank in a digital format and it is no different from hard cash, apart from the fact that they are in a digital or virtual form. It is not meant to replace hard cash, but co-exist as an additional form of payment method.

2. The idea for central bank digital currencies stems from cryptocurrencies. CBDCs are backed by a government and recognised as legal tender where they have been implemented. So far, in the UAE, it has been used as a cross-border payment among governments.

3. So a central bank digital currency is the digital form of a country's fiat currency. A CBDC is issued and regulated by a nation's monetary authority or central bank. CBDCs promote financial inclusion and simplify the implementation of monetary and fiscal policy.

4. As a centralised form of currency, they will not anonymise transactions as some cryptocurrencies do.