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Why governments are launching Central Bank Digital Currencies? PBoC’s CBDC explained

Central Bank Digital Currency

Last month, news broke that China is getting ready to launch a digital version of its currency, the renminbi. The People’s Bank of China (PBOC) issued Central Bank Digital Currency (CBDC) will be backed in 1:1 ratio with the renminbi and will reportedly, aim to replace the Chinese cash in circulation also known as the M0 money supply. 

And it’s not just China several others like the Marshal Islands, India, Estonia, and many others are reportedly launching their own nationalized cryptocurrencies. On that note, it’s important to ask why these countries are launching their own national digital currency? 

But before we get into that, an important distinction has to be made — the difference between a Digital Currency and a Cryptocurrency.

Digital currencies and Cryptocurrencies are not the same.

A digital currency is money that exists only on the internet, which means its digital money that has all the traditional characteristics of money but doesn’t have a physical form. The main advantage with digital currencies includes enabling, instant transactions, easy accessibility and cross-border transfer of ownership. 

This definition implies that all Cryptocurrencies are a form of Digital Currency but the reverse isn’t always true. So what’s a Cryptocurrency? 

A digital asset designed to be used as a medium of exchange. Cryptocurrencies used advanced cryptography techniques to enable the transfer of assets, creation of additional units, and to verify transactions. Also, cryptocurrencies use Distributed Ledger Technology (DLT) to enable decentralized control of its network. The most commonly used DLT is Blockchain although several new, purportedly superior, public DLT’s like Hedera Hashgraph are popping up.

This is the reason why China’s CBDC is being called a digital currency and not a cryptocurrency because, as of now, it’s not clear if it uses a Distributed Ledger technology like Blockchain to serve as a public financial transaction database. On the other hand, according to a report by Bloomberg, the Marshal Islands plan on launching a nationalized cryptocurrency as it uses Blockchain technology.


China’s Central Bank Digital Currency backed by Renminbi

Here’s what we know so far about China’s Digital Currency. Firstly, China has allegedly been working on this since 2014. That’s five years in the making. The idea was to cut the costs of circulating physical cash and also boost the policymakers control over the money. So what has prompted China to roll out its product right now? 

According to several mainstream Chinese news sources, the introduction of Facebook’s Libra project might have been a catalyst. This is because of growing concerns that continued capital outflow that could weaken the renminbi. In several instances, officials from PBoC has compared the Chinese CBDC with the Libra project, stating its technology is more advanced.

Libra’s official release date is set to be in 2020 but it’s unlikely to launch by then because of the overall negative sentiment regulators and governments have towards it. Some countries like France have agreed to block the project if it rolls out. 

This isn’t the first time a country has launched a cryptocurrency. In 2017, the government of venezuela launched Petro supposedly in an effort to curb inflation and circumvent US sanctions. The Petro digital currency was designed to be backed by the oil, gold and diamond reserves of the country. It remains as one of the largest token sales to date at a whopping $735 million although the government of venezuela claims it has raised well over $3 billion. This claim couldn’t be confirmed.

Central Bank Digital Currency

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China’s Central Bank Digital Currency features

China’s CBDC shares similarities to Stablecoins, in the sense that it will be backed by real assets. According to an announcement by the PBoC, the Chinese CMBD will be 100% backed by reserves that commercial institutions pay to them. 

Notably, Payment service providers in China like Alipay and Wechat are also 100% backed by reserves but this wasn’t the case until 2018. For over a decade, the Central Bank of China didn’t require third-party payment companies to assets backing its payment system. And as of January 2018, all third-party payment firms are required to deposit 100% of their reserves of client funds with a centralized custodian. This boosts a policymaker’s control over the money. 

As we mentioned earlier, the PBoC cryptocurrency cannot be considered as Cryptocurrency like Bitcoin as far as we know, the technical details of its roadmap are still unclear. Even if a Distributed Ledger Technology like Blockchain is used to create a transaction database, we still can’t China’s CBDC as a cryptocurrency because it will be issued and managed by a single entity. 

According to a research report by Binance, it’s likely the PBoC will have 100% control over Chinese CBDC to ensure monetary sovereignty and effective transmission of monetary policy.

Why is China launching a Central Bank Digital Currency?

The People’s Bank of China aims to replace China’s MO supply, i.e the supply of physical cash, with its CBDC. This move could improve the Chinese Financial System in several key areas.

For example, as the CBDC shares the main characteristics of cash it can improve retail payments by augmenting portability and anonymity. But this point is debatable, as to use a central bank issued digital currency, users would have to meet KYC rules, which makes the anonymity part questionable as the government has complete access to the ledger of transactions, unlike most cryptocurrencies.

There’s also speculation that the increased efficiency and lower costs for cross-border payments could help encourage the adoption of the Chinese renminbi as the global currency from the current US dollar. The country has already taken several steps to enable this to happen, the first being accepted as a reserve currency. A status that was awarded back in 2015 by the International Monetary Fund. Now the approved imf digital currency could do wonders to the chinese economy. Check out this Bloomberg article to know why it’s beneficial for China if the renminbi becomes a global currency.

Also, by encouraging people to shift from cash to a digital currency the government can easily crackdown on illicit activities and implement strong money-laundering policies, as physical cash is critical for these illicit nexuses to function.

But the PBoC also claims that these digital transactions will be anonymous from the user’s perspective. How? Its CBDC coin will contain a user’s id and their information and every time it is transacted it will generate a new CBDC string that now includes the new user’s information.

Mu Changchu, the deputy director of the PBOC’s Payment and Settlement Department in his speech on August 10th stated that China’s CBDC will aim to strike a balance between anonymity and KYC/AML policies.

Central Bank Digital Currencies could Bank the Unbanked?

According to some of the early documents related to China’s CBDC, it’s likely that the country will adopt a system that enables fund transfer without the need for a bank account. This makes sense as China has 1.58 billion mobile phone subscriptions as of February 2019. 

Reports suggest, that China’s CBDC will be built on a two-tier system meaning it would be distributed across two distinct layers. The first layer is between the central bank & commercial banks i.e between the centralized institutions. The second layer is between commercial banks and individuals, businesses.

These are all assumptions of how China’s CBDC would function and what characteristics it holds based on documents obtained for prototypes. The final version is yet to be finalized and it involves very critical questions like what technology will be used in the second layer i.e between banks and institutions

 

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