The introduction of the Central Banking Digital Currency (CBDC), a consequential fintech innovation in the past decade, has triggered debates on what differentiates CBDCs and existing cryptocurrencies. This post will examine some of the major differences between CBDCs and cryptocurrencies, namely issuance, impact on the real economy and treatment of existing infrastructures such as banks.
What are CBDCs and cryptocurrencies
CBDCs are an electronic form of central bank money that could be used by households and businesses to make payments, and that is different from balances in traditional reserve or settlement accounts. Sweden’s e-Krona and China’s DC/EP are examples of CBDCs, as explained in our last blog post.
Cryptocurrencies are electronic currencies that are secured by cryptography and often issued on a decentralized platform based on blockchain technology. Bitcoin and ether are common examples of cryptocurrencies.
Both CBDCs and cryptocurrencies are digital currencies, but differ on various counts. The most significant is the most obvious – CBDCs are legal tender and have the full backing of the state and existing financial institutions, whereas cryptocurrency works within a closed network and has its own monetary policy. Let’s break this down a bit further.
How CBDCs and cryptocurrencies differ on issuance
CBDCs are issued by a centralized authority, the central bank, whereas cryptocurrencies do not have a centralized issuance body, and are instead generated on a decentralized platform. A good example is bitcoin, which is minted by a machine-driven mining process, and governed by a global online community instead of a centralised body.
How CBDCs and cryptocurrencies differ on their impact on the real economy
Cryptocurrencies are not legal tender in most jurisdictions and are not widely leveraged for activity in the real economy. CBDCs, on the other hand, directly feed the real economy, as they are issued by a central bank and replace cash usage by citizens and businesses.
By virtue of being digital legal tender, CBDCs have the potential to change the manner in which business, finance and other processes work. A natively digital currency solves for a lot of non-digital elements in the flow of commercial transactions today.
How CBDCs and cryptocurrencies differ on disintermediation of financial institutions
A major difference between CBDCs and cryptocurrencies lies in their impact on existing institutional structures in the financial system. Cryptocurrencies operate on decentralized systems independent of the banking system. CBDCs however, could disintermediate the banking system, as indicated in our previous blog post.
The introduction of interest-bearing CBDCs could adversely impact the banking sector in the country. If central banks were to start offering these interest-bearing instruments, it would create a more trustworthy deposit than commercial banks. As a result, there could be mass movement of of liquidity away from commercial banks which would threaten their business models.
There are different options for CBDCs to reduce potential disintermediation. For instance, central banks can choose not to offer interest or credit facilities such as overdrafts to users.
China has taken a very innovative approach to avoiding disintermediation, as we have explored in our report series on China’s Digital Currency (link). We have also explored some of the similarities between CBDCs and cryptocurrencies in the report series. You can gain early access to our first report on Unraveling China’s DC/EP: An Overview by signing up here.