What is CBDC? What types are there? Understanding Central Bank Digital Currency (CBDC) at once

At the intersection of tradition and innovation, a new form of currency may be reshaping our financial landscape, and that is the Central Bank Digital Currency (CBDC) carrying immense potential.

However, you may wonder, can CBDC really make our lives better? To this end, we invite you to follow our article and explore this rare digital opportunity together, witnessing how this global financial technology revolution can spark endless possibilities for the future.

What is CBDC?

Central Bank Digital Currency (CBDC) refers to the digital version of a country's national currency created by the central bank. The basic concept is for a country's central bank to issue a digital form of the national legal tender currency and control its issuance and circulation. Unlike traditional paper money or coins like the US Dollar or New Taiwan Dollar, CBDC can be used for payments but in digital form.

While most CBDCs in various countries are currently pegged to a specific legal tender, they can also be pegged to the value of specific assets.

You can think of CBDC as a digital version of cash, similar to the money in our bank accounts, but directly issued and regulated by the central bank of a country.

It's worth noting that CBDC is often misunderstood as "requiring blockchain technology only," but any technology that records all transactions and cannot be altered could serve as the underlying technology for CBDC, with blockchain and distributed ledger technology being the more prevalent methods currently.

Regardless of the method chosen by central banks, the common goal is to ensure transparency in every transaction and prevent criminal activities such as fraud and money laundering.

CBDC vs. Fiat Currency vs. Cryptocurrency

In general, fiat currencies, CBDC, and cryptocurrencies are all forms of digital currencies, but they have significant differences in issuance, regulation, and privacy protection.

The following table compares fiat currency, CBDC, and cryptocurrency to help you understand the differences among these currencies:

Regarding Central Bank Digital Currency (CBDC), it is a digital form of the legal tender currency issued by the central bank. It corresponds to a specific asset or legal tender and can be exchanged one-to-one, but its issuance and transactions are controlled by a single authoritative institution, making them fundamentally centralized.

Benefits of Government-Issued CBDC?

In general, issuing CBDC can address various financial issues, including:

• No credit and liquidity risks
• Reduced cross-border payment costs
• Inclusive finance accessible to everyone
• Easier implementation of monetary policies

Management consulting firm McKinsey points out that CBDC can effectively address efficiency and security issues in finance at a low cost.

Since CBDC can be held with a simple digital wallet, it eliminates the need for strictly regulated bank accounts to access CBDC-related services, which is a significant help for developing countries or underserved populations.

CBDC also enables quick, cheap, and transparent cross-border payments. It allows funds to be transferred across borders instantly within seconds, with significantly reduced transaction costs. This will help facilitate international trade and economic globalization.

As CBDC is directly issued and supported by the country's central bank, it is not subject to value fluctuations like some cryptocurrencies, giving users higher confidence in its value and reliability.

Finally, CBDC allows governments to execute monetary policies more efficiently. In traditional monetary policy, adjustments such as interest rates, inflation, and economic growth usually require complex processes like buying and selling government bonds. However, CBDC provides a direct tool, such as enabling central banks to adjust CBDC interest rates directly, influencing economic indicators within the economic system.

Types of CBDC: rCBDC vs. wCBDC

CBDC can be categorized as retail CBDC and wholesale CBDC based on whether they are designed for general public use or interbank transactions:

• rCBDC (Retail CBDC): This type of CBDC, designed for general consumers and businesses, offers higher transaction efficiency and security compared to traditional digital payment systems. Retail CBDC not only facilitates transactions with digital currency but also provides higher reliability due to being issued by the central bank and is more accessible to populations who may have difficulty accessing services in traditional banking systems.
• wCBDC (Wholesale CBDC): This type, primarily used by financial institutions, operates similarly to current digital payment systems but is directly issued and managed by the central bank. The main purpose of this CBDC type is to enhance transaction efficiency and transparency among financial institutions.

In addition, CBDC can be further classified into "account-based" and "token-based" modes of operation. Account-based CBDC, such as DCash implemented in the Eastern Caribbean region, represents an account opened by individuals or companies at the central bank, where transactions are directly deducted from this account when making purchases. Token-based CBDC exists in the form of digital tokens, representing electronic versions of coins and banknotes that only the central bank has the authority to issue to commercial banks.

It is important to note that these types are not mutually exclusive. In other words, retail CBDC can operate in either account-based or token-based modes. Different central banks may choose the appropriate CBDC type and operation mode based on their specific needs and considerations.

CBDC Risks: What Challenges Does CBDC Pose?

While Central Bank Digital Currency (CBDC) can promote financial inclusivity and activity, it may also bring new challenges. The following risks are essential considerations when discussing CBDC:

• Privacy and Protection: Unlike the anonymity of cryptocurrencies, every transaction with CBDC will be recorded and potentially traceable, possibly requiring user identification. This means governments and central banks may have greater capabilities to monitor the financial activities of the public.
• Increased Central Influence on the Economy: CBDC will grant central banks more power to influence money supply and financial policies, affecting factors like inflation, interest rates, loans, and consumption, thereby impacting economic indicators like employment rates.

For example, if a central bank chooses to reduce CBDC supply to control inflation, it could lead to a decrease in purchasing power, resulting in increased household expenses. Additionally, this could potentially raise interest rates, affecting investments and economic growth. This increased power may lead to excessive control by central banks over the economy and pose risks of abuse of power.

• System Stability and Information Security: Cryptocurrencies have always been a target for digital hackers, and digital currencies issued by central banks may also attract similar criminal groups. Therefore, strong measures are necessary to prevent system breaches and protect assets and information.
• Complex and Costly Implementation: Ensuring the secure and effective operation of CBDC systems, such as banks and consumer institutions supporting CBDC equipment, may require significant technical and manpower investments, potentially resulting in expensive CBDC implementation.

Global Development Status of CBDCs: Which Path Should CBDCs Take?

The global development of Central Bank Digital Currencies (CBDCs) is gaining momentum. According to research by the Atlantic Council of the United States focusing on international relations, as of December 2022, 10% of the 120 major countries worldwide have issued CBDCs, and 95% of the countries (114 countries accounting for 95% of global GDP) are exploring the possibility of CBDCs, with 60 countries already in the advanced exploration stage.

The International Monetary Fund (IMF) notes that over 40 countries have requested assistance in CBDC capacity development.

As for the development status of CBDCs in different countries, we outline the current situations of Taiwan, the United States, and China to explore:

CBDC Development in Taiwan:

• In October 2021, the Governor of the Central Bank, Yang Chin-long, mentioned that Taiwan completed the wholesale wCBDC test in June 2020 and found limitations in the application of Distributed Ledger Technology (DLT). The second phase of the general CBDC experimental plan will simulate CBDC retail payment scenarios in a closed environment, with completion expected by September 2022.
• In June 2022, Yang Chin-long announced that the second phase of Taiwan's "General CBDC Trial Plan" had been completed three months ahead of schedule. The next phase planning will include "extensive communication to gain public support," "improving platform design using more robust and mature technologies," and "deliberating a solid legal framework," with completion expected in 2025.

Overview of Taiwan's Central Bank Digital Currency Progress: What are the benefits and risks of CBDC? At what stage is the trial progress?

CBDC Development in the United States:

• In 2022, President Biden's executive order positioned the development of a US CBDC as an urgent task.
• The wholesale CBDC experiment by the New York Federal Reserve System, known as the Cedar project, has progressed the US from the research stage to the development stage.
• A report released by the White House in 2022 mentioned technical details and related options for the potential development of a US CBDC.

FedNow set to launch in July, how does it differ from stablecoins and CBDCs?

CBDC Development in Mainland China:

• China's Central Bank Digital Currency (CBDC), known as the digital Renminbi (e-CNY).
• China leads in global CBDC development and adoption. The Chinese government has introduced encryption laws and amended the People's Bank of China Law to accommodate digital currency development. It recently announced plans to leverage the digital Renminbi in the Belt and Road Initiative expansion.
• French bank BNP Paribas, as the first foreign institution to partner with Chinese banks, enables its corporate clients to seamlessly transact in China's CBDC.

Explore more countries' CBDCs

As a novel innovation in the fintech sector, CBDCs have profound implications for reshaping the global economic system. The evolution of CBDCs and their impact on our financial ecosystem should be closely monitored with a professional perspective, and we look forward to witnessing further developments and breakthroughs in the field of CBDCs in Taiwan.