Explained: How do CBDCs differ from cryptocurrencies?

After India, the US is mulling its central bank digital currency (CBDC) which will be issued and regulated by the federal bank. In an executive order, US President Joe Biden told federal agencies to propose new rules to regulate cryptos and come up with a plan to develop and deploy CBDC, which would be interoperable with CBDCs issued by other monetary authorities in other countries. In some countries including China and the Bahamas, government-issued CBDCs are already in circulation. 

The push to develop a central digital currency regulated by the government, be it in India or the US, stems from the growing use of cryptocurrencies for money laundering and other illegal activities. CBDC will exist alongside cash and bank deposits. 

What is a government-backed digital currency?

CBDC is a digital currency that will be issued and regulated by central banks. In India, it will be regulated by the Reserve Bank of India (RBI). Though cryptos run on Blockchain, a CBDC may not necessarily be blockchain-based. Last month, RBI’s Executive Director T Rabi Shankar had said that CBDC may not necessarily use blockchain and the bank is considering other technologies too. Even if RBI decided to use blockchain, it will be essentially a private blockchain where one single organization or bank will control the entire network. In such networks, transactions will remain private and only the central authority will be able to know the details. 

How is it different from cryptos such as Bitcoin?

Cryptos such as Bitcoin are based on public blockchain networks, which are decentralised, offer anonymity and where transactions cannot be regulated by a bank or central authority. Whereas, CBDC is nothing more than a digital form of the government-issued currency, where banks will have completed knowledge of one’s assets and transactions. If CBDC is based on blockchain, transactions will still be validated but consensus will be achieved through selective endorsement. Only authorised entities have the permission to validate a transaction. In a public blockchain, anyone can become a validator as long as they have the required hardware to process it. The validator’s identity also remains anonymous on public blockchains.  

Why are governments pushing for their digital currencies 

Governments want their CBDCs for various reasons. The most crucial among them is to wean people from investing cryptos and ensure financial stability for the country. Cryptos are inherently volatile. For instance, the value of Bitcoin soared to a record high of $69,000 in November 2021, and within months fell to $38,964. Experts believe that CBDCs can potentially offer more resilience, safety, and lower costs as compared to cryptos. In addition to financial stability, CBDC can also improve the speed of cross-border transactions. It can be exchanged instantly as one won't have to wait for approval from their respective banks for transactions. CBDC can also come in handy to access legal tender in locations where cash is not accessible. This can help governments achieve financial inclusion.