How central bank digital currencies could impact the digital currency market
Central Bank Digital Currencies and government-backed digital assets, coupled with private crypto projects, are set to galvanise the crypto-sphere on account of their scalability and efficiency.
By Brand Connect
Looking to get classified as a global asset class, crypto or digital tokens trace their roots back to the creation of the Bitcoin blockchain in 2009, when its creator Satoshi Nakamoto introduced the world to a new system of peer-to-peer payment transactions without the need for a central authority to govern them. Over the past few years and especially since the onset of the COVID-19 pandemic, these tokens have evolved as an investment avenue and the global appetite for cryptocurrencies has grown rapidly on account of the increased security, transparency, and inflation-protection offered by them. However, with the proliferation of public digital currencies like Bitcoin (BTC) threatening the ability of governments to manage their economies, various central banks are also conducting trials to launch their own sovereign-backed virtual currencies called Central Bank Digital Currencies (CBDCs) based on Blockchain technology. While the only similarity between CBDCs and public and permissionless crypto assets like BTC & Ethereum (ETH) is the underlying Blockchain technology, there are many key features that explain why the introduction of CBDCs into the crypto ecosystem could accelerate traditional finance into its high-tech future.
While both sets of digital currencies use Blockchain technology at the core, CBDCs differ from other crypto in the sense that they will be issued/stored using a central authority while relying on Blockchain’s time-stamped record blocks to encrypt transaction activity and continuously verify the same using network participants. This characteristic is considered to be far more tenable for considering CBDCs as a payment token and a legal tender; and therefore is aimed at making transactions safer than even commercial bank-issued digital money. Moreover, with the value of a CBDC being directly linked to the nation’s fiat currency, its value is only subject to forex related fluctuations and makes it less volatile, thereby reducing the impact of speculative forces. These inherent differences make CBDCs less susceptible to the market volatility that is commonplace with most crypto, while also benefiting from being directly backed by the issuing central bank, just as is the case with fiat money. There are however some challenges with CBDCs, including concerns around user privacy, interoperability with other virtual assets, scalability of the underlying blockchain and possible concentration risks, which will hopefully be addressed as they develop further. On the other hand, permissionless digital tokens like Bitcoin and Ethereum are maintained in decentralized public ledgers that are borderless which are not fully subject to regulatory oversight yet. Since this particular asset class has become a choice of investors only recently (just over a decade), the value of these tokens in the secondary markets is prone to higher market volatility on account of global open market operations. Further, given their inherent complexity and potential promise of high returns, investors are also susceptible to frauds, hacks, scams and market manipulation. Considering the fact that literally anyone can create a token, a few malicious entities have created cryptos or NFT projects without any utility thereby leading to occurrences where investors have lost their capital on account of pump and dump schemes or rug pulls. That being said, crypto has unique use cases that are revolutionizing the way the world is transacting today. Key example of this being how Ethereum (ETH), one of the most highly traded cryptos, is supporting a fast developing entire ecosystem of decentralized apps (dapps) and smart contracts that are facilitating the rise of crypto assets like Non fungible tokens (NFTs) today. NFTs are finding their way into more common use-cases including gaming, ticketing, art auctions, etc.With many new cryptos having unique use cases consistently being introduced, the global crypto market has grown substantially over the past few years to hit a record of $3 trillion in 2021.
The launch of CBDCs will be an extremely crucial development for the ecosystem and the amount of interoperability with virtual assets baked into CBDCs will define the nature of co-existence that will follow. In the absence of such interoperability, CBDCs will not only have to build robust and scalable blockchain based infrastructure, but will also have to build and define incentive mechanisms and use-cases for their large scale proliferation. Either way CBDCs are the next frontier which will cause a tectonic shift in both the current digital currency ecosystem and the global financial system as we know it. As the more central banks come forward to launch their own CBDCs, they will aim to become the sole intermediaries for all related financial transactions and the primary focus might shift to wholesale applications that offer distinct benefits to the backend infrastructures underpinning current payment systems. Commercial banks on their part could then borrow wholesale in CBDCs to finance their lending activities, with competition amongst them based entirely on their ability to bridge short-term and long-term interest rates efficiently.
This will in turn result in them engaging in value-creating projects and drive competition for distributing their electronic wallets through innovative and user-friendly solutions. CBDCs will thus facilitate the entry of new FinTech players that aren’t dependent on existing physical banking networks or their paper cash outlets and lead to easier financial policy regulation or execution. Additionally, CBDCs enjoy the traceability benefits of crypto, which make the detection of criminal activity easy as the digital ledgers will be visible to the clearing institutions and once a globally interconnected network of CBDCs is in place, agencies across the world could work together to eliminate the black markets that are characteristic of countries that deal largely in physical money today.
With both CBDCs and private cryptos having vastly different modes for value creation, the global crypto adoption is sure to rise with the introduction of more CBDCs going forward. Reduced costs of operations, better risk management and promotion of greater financial inclusivity will serve as important catalysts to the rise of CBDCs in the near future. If the fundamental issues of basic privacy, interoperability, etc are addressed, CBDCs undoubtedly will help governments across the world to introduce sovereign digital currencies that can support better traceability, highly efficient operations, and faster transaction speeds. With greater control on the transmission of monetary policy, CBDCs can potentially help central banks execute the original intent of crypto with more efficiency while truly protecting the interests of the end-consumer.
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