As the central bank digital currencies (CBDCs) continue to gain mainstream adoption and traction across the world financial landscape in recent years, nearly all central banks are now actively researching the risks and benefits of floating a digital currency to their public. Decentralized CBDCs might pique the interest of the public much more than the centralized versions, according to research.
In the most basic sense, a CBDC is a digital type of fiat money that is backed by a suitable amount of monetary reserves including gold and foreign currency reserves. Every CBDC unit operates as a secure digital instrument that is equivalent and can be used as a means of payment, a store of value, and maybe an official unit of account.
What separates them from stablecoins, which are similar digital offerings whose value is pegged to fiat, is that they are issued by governments and backed by central bank-issued money. This aspect makes them completely regulated.
China’s Digital Currency Electronic Payment (DCEP) project seems to be the most advanced CBDC trial. It has already been rolled out for consumer testing across the major regions of the Asian nation including Shenzhen, Suzhou, Beijing, and Chengdu most recently.
China is reportedly aiming to release the digital yuan before next year’s Winter Olympics. Thus, it is now positioning itself as a world leader within the digital currency space. While the digital yuan was originally quite limited in its general scope of use, its expansion has been quite explosive in the last few months.
Digital currency was most recently being used for several large-scale digital transactions including ATM withdrawals and online shopping. Moreover, to help the users understand the value proposition put forward by CBDCs, China’s government has already engaged with many educational blockchain projects.
They have engaged with these projects aiming to help its population deepen its understanding regarding the smart contracts, decentralized technology, and other niches that are related to this ever-growing and ever-evolving space.
Decentralized CBDCs Now Conceptualized
As things stand currently, for a central bank digital currency to be adopted by any state, it has to comply with the region’s existing monetary policies. While still curious about CBDCs, central banks are still apprehensive about digital assets. They are hesitant because the digital assets introduce a level of decentralization into the equation that majorly challenges how the banks’ current governance protocols work.
For the governments that are aiming to digitalize their economies via the use of CBDCs, it appears obvious that for the offerings to truly succeed, they have to benefit from the most revolutionary aspect put forward by cryptos and blockchain technology in general: decentralization.
While a majority of the CBDC projects that have been postulated in the last several years aim to enable peer-to-peer transactions, they appear to use governance frameworks that are generally authoritarian. This means that they are centralized and entirely controlled by one body which in most cases is the government.
Nevertheless, as the public trust in banking institutions and governments continues to dwindle, there is a minimal incentive for the consumers to adopt these types of CBDCs. Thus, it now stands to reason that there truly does exist a great window of opportunity for the creation of digital currencies that are decentralized in their governance and general scope of utilization.
Notably, there are already various solutions in the current market that can help in making the vision a living reality. Some blockchain ecosystems appear to come replete with decentralized digital identity solutions.
The solutions can enable the central banks and other authorized financial institutions to easily and efficiently eliminate the identities of people and entities suspected of committing crimes while simultaneously protecting the privacy of its other CBDC users.
These platforms do not need users to upload information directly onto a major server, but instead upload some encrypted information that is just transmitted through a secure end-to-end encrypted network that cannot get intercepted.
Moreover, since such frameworks enable CBDCs to operate in a decentralized and transparent manner, they can facilitate the creation of complex logic contracts and financial tools like derivatives and bonds.
Why Is Decentralization Better?
The most commonly used architectural design for retail CBDCs appears in the form of a permissioned distributed system that does not have to essentially reside on a blockchain. Due to that, these systems seem to consist of a single point of failure, and given the fact that CBDCs are important and can be integral in a country’s economic growth, all these risks have to be minimized and eliminated at all costs.
With that said, if a central bank’s digital currency were to be created in a distributed fashion, the aforementioned risks may be eliminated from the picture. Another major point to consider is that the centralized blockchains are still relatively slow. Hence, the use of decentralized solutions, like distributed ledger technology, stands to make CBDC transactions much faster and more streamlined.
To ensure that the digital currencies grow, transaction speeds have to be extremely efficient, otherwise, a payment system that is reliant on such tokens is unlikely to succeed.
Decentralization also enables individuals to own their wallets, as well as own their private keys. That means that the custody of a person’s coins is always with them and not with a centralized body. That can help in avoiding many of the data breaches that have been seen in the past. Such incidents could be catastrophic if the funds were stored in one centralized location.
ECB To Veto Powers Over Stablecoins Operating In The Eurozone
Another argument for the decentralization of fiat-tethered cryptos is that as more and more nations begin to make use of CBDCs and other stablecoins, central banks globally will try to tighten their regulatory strings and measures over these offerings because they stand to put some dent in their control over banking, payments, and the supply of money.
In this regard, the European Central Bank recently told the European Union legislators that it now wants to complete veto authority. The veto targets the launch of stablecoins, including Facebook’s Diem in the eurozone, and plays a bigger role when it comes to the supervision and comprehensive regulation of the digital assets.
The European Union members have recently been working toward developing an exhaustive and extensive set of rules for the governance of cryptocurrency assets, including stress tests together with capital and liquidity needs since September 2021. A recent guideline reads:
“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 European Central Bank is working on a digital euro. The asset is most probably going to make its way into the global financial network after a lot of regulatory scrutiny and testing within the coming four years.