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Decentralized CBDCs are expected to pique the public’s attention even more than their centralised counterparts.
As central bank digital currencies, or CBDCs, have gained widespread momentum across the global financial world in recent years, almost all central banks are aggressively exploring the advantages and dangers of making a digital currency available to the public.
A CBDC, in its most simple form, is a digital form of fiat money backed by a sufficient sum of monetary reserves such as gold or foreign currency reserves. Each CBDC unit functions as a safe digital instrument counterpart and can be used as a payment method, a store of value, or an official unit of account. They differ from stablecoins, which are related digital offerings whose value is pegged to fiat, in that they are distributed by the government and backed by central bank-issued currency, making them fully controlled.
China’s Digital Currency Electronic Payment, or DCEP, initiative is arguably the most advanced CBDC trial, with market trials already underway in major cities such as Beijing, Suzhou, Shenzhen, and, most recently, Chengdu. China is promoting itself as a global pioneer in the digital currency market, with the nation planning to unleash the digital yuan before next year’s Winter Olympics.
While the digital yuan was initially quite limited in its overall scope of use, its expansion has been quite explosive over the course of the last few months, with the digital currency most recently being utilized for a number of large-scale digital transactions including online shopping, ATM withdrawals, etc.
Furthermore, to help people understand the value proposition put forth by CBDCs, the Chinese government has already engaged with several educational blockchain projects, to help its population deepen their understanding in regard to decentralized technology, smart contracts and other niches related to this ever-evolving space.
Decentralized CBDCs conceptualized
Currently, in order for a CBDC to be implemented by any jurisdiction, it must adhere to the region’s current monetary policies. Although central banks are intrigued by CBDCs, they are also wary of digital assets because they bring a degree of decentralisation into the equation that clearly undermines the way their current governance protocols operate.
For governments seeking to digitalize their economies through the use of CBDCs, it is clear that in order for these offerings to fully flourish, they must profit from perhaps the most innovative feature of cryptocurrencies and blockchain technology as a whole: decentralisation.
While most of the CBDC projects that have been envisioned over the last few years seek to enable peer-to-peer transactions, they tend to make use of governance frameworks that are authoritarian in nature — i.e., they are centralized and controlled by a single body. However, as public trust in governments and banking institutions continues to erode, there is little incentive for consumers to adopt such kinds of CBDCs.
As a result, it stands to reason that there is a genuine window of opportunity for the creation of digital currencies that are decentralised in their administration and general breadth of use. In truth, there are already options on the market that can assist in making this vision a possibility.
There are blockchain ecosystems that provide shared digital identification technologies, allowing central banking agencies to quickly and reliably root out the identities of persons accused of committing crimes while preserving the anonymity of the other CBDC users.
Such platforms do not enable users to send data directly to a computer, but rather to upload encrypted data that is only distributed via a protected end-to-end encrypted network that cannot be intercepted. Furthermore, since such mechanisms allow CBDCs to operate in a completely decentralised and transparent manner, they can promote the development of complex logic contracts and financial instruments such as shares, derivatives, and so on.
Here’s why decentralization is better
The most commonly employed architectural design for retail CBDCs comes in the form of a permissioned distributed system that does not have to necessarily reside on a blockchain. As a result, these systems tend to feature a single point of failure, and given how important CBDCs can potentially be to a country’s economic growth, such risks need to be mitigated at all costs.
However, if a CBDC is designed in a distributed manner, the above risks may be absolutely removed from the frame.
Another consideration is that centralised blockchains are also relatively slow, but the use of decentralised implementations, such as distributed ledger technology, has the potential to make CBDC transfers much quicker and more streamlined. To aid the growth of digital currencies, transaction rates must be incredibly fast; otherwise, a payment system based on such tokens is unlikely to succeed.
Decentralization often encourages people to own their own wallets and private keys, implying that the ownership of one’s coins is still with the user, rather than with a centralised entity. This will help prevent much of the data breaches we’ve experienced in the past, which could be disastrous if funds were kept in a single location, for example.
ECB wants veto powers over stablecoins operating in the eurozone
Another reason for the decentralisation of fiat-backed cryptocurrencies is that if more countries want to use CBDCs and stablecoins, central banks around the world will tighten their regulatory purse strings on these offerings, fearing that they will undermine their control over transfers, credit, and money supply.
In this regard, the European Central Bank, or ECB, recently told European Union lawmakers that it needs absolute veto authority over the implementation of stablecoins in the eurozone, such as Facebook’s Diem, as well as a stronger position in the regulation and management of digital assets.
Since September 2020, EU members have been working to create a comprehensive set of rules for the regulation of crypto assets, including stress tests and capital and liquidity requirements. According to a revised policy:
“Where an asset-reference arrangement is tantamount to a payment system or scheme, the assessment of the potential threat to the conduct of monetary policy, and to the smooth operation of payment systems, should fall within the exclusive competence of the ECB.”
Even the ECB is developing its own digital euro, with the commodity most likely to enter the global financial environment following extensive regulatory review and testing over the next four years or so.