Central Bank Digital Currencies

Since the Chinese eCNY was promoted during the 2022 Winter Olympics, Central Bank Digital Currencies have been in the news. Central banks worldwide have acknowledged the need and technological benefits of cryptocurrencies. Many Governments and Central Banks have created CBDCs, and many are in the process. 

Let us have a brief overview of what CBDCs are and what benefits they offer, and the challenges they might face.

The Idea Of Cryptocurrencies

Cryptocurrencies came in the wake of the 2008 Global Financial Crisis that caught many people unaware. Many people lost their homes, jobs, education, and means of livelihood. This distrust over a centralized finance system is believed to have led to the birth of cryptocurrencies. 

The idea of a digital currency was not new. Hashcash was a digital currency in the 1990s. The only hurdle was to solve the double-spending problems, which was to create a digital currency that could be sent to only one person at once and not copied and sent to multiple persons.

Cryptocurrencies that came early solved the double-spending problem and designed community-based verification methods such as Bitcoin and its proof-of-work. These methods eliminated the need for a central authority.

Why Central Banks Opposed It

The prime reasons for opposition from central authorities such as Commerical Banks, Federal Reserve, Central Banks, and various governments were two core issues.

• Non-Traceability – Involvement in money laundering. Usage in the dark web, such as for purchasing drugs.
• Undermining Sovereign Authority – Governments and Central Banks view that these cryptocurrencies erode the power of fiat currency. But even with a 3 trillion US Dollar market, there is hardly any devaluation for the central bank-issued currencies. Contrary to this, inflation caused by central banks’ stimulus has been absorbed by cryptocurrencies.

There was an intense debate over the issuance and legality of cryptocurrencies. Many countries classified them as assets. Others gave them a free run. Many resorted to heavy taxation.

Something peculiar happened during the debate over cryptocurrencies: Many central banks began trials and discussions upon Central Bank-issued Cryptocurrencies. These cryptocurrencies have a host of benefits as well as serious issues.

What Is CBDC?

Central Bank Digital Currencies is perhaps the most popular term used to describe them. CBDC is cryptocurrencies supported by the Assets and Faith of Sovereign Governments. It would be par with fiat(normal) currencies and harness the benefits of blockchain technology.

• Very likely to be at par with fiat currencies.
• No risks of devaluation
• No risk of currency collapse
• Better infrastructure as compared to cryptocurrencies
• Better equipped to punish perpetrators
• Better resilience against future challenges

CBDCs Till Now

There have been numerous CBDCs, such as Marshall Islands Sov, Venezuela’s Petro, China’s e-CNY, and various upcoming cryptocurrencies such as India’s Digital Rupee and Russia’s Digital Ruble. Let us discuss a few of them in brief:

• Sov – Island nation of Marshall Islands announced SOV as its legal tender in 2018. There are a total of 24 Million SOV to be issued.
• Petro – The currency crisis and hyperinflation in Venezuela forced the government to issue Petro, a cryptocurrency equivalent to one barrel of crude oil. Since it is commodity-pegged and with rising crypto prices, it can greatly help them with blockchain security.
• eCNY –  China’s eCNY is a digital currency issued by its central bank (The People’s Bank) and featured in the 2022 winter Olympics.
• Digital Rupee – The government of India announced in early 2022 that it would launch a digital currency based on a blockchain. Touted to be the Digital Rupee, this currency will be at par with the fiat Indian Rupee. The roadmap is still unclear, but it should be a success with increased enthusiasm. Further, unlike China, cryptocurrencies are not banned in India.

Risks To CBDC

Credentials Theft 

If login credentials are not secure properly, anyone cannot prevent credential theft. Developers can make a system as secure as possible, but hackers can change the entry point to the system by cloning it, as in the case of Password Vishing. This is the most common way of cybercrime.

Quantum Computing

Quantum computing is a big threat to blockchain security because of its ability to process huge amounts of information. If the nonce values are guessed, then anyone can manipulate information. Still, it might not be a near-future threat.

Lack Of Technological Understanding

Lack of awareness regarding cyber-security makes thousands of crimes possible every year. Blockchain, a newer technology, would require more time to understand it and its best security practices.

Consensus Mechanisms

Every consensus mechanism has its drawbacks, such as Sybil attacks in Proof-of-Stake. The central bank’s digital currency has to be based on mechanisms that can handle large numbers of transactions and security.

The Road Ahead

Central Banks have long opposed the idea of cryptocurrencies for many reasons. Hence, many central banks and sovereign financial systems have adopted an approach to creating central bank digital currencies. But with their popularity and technological benefits, no one cannot ignore cryptocurrencies.