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What You Need to Know About Central Bank Digital Currency and How It's Different From Cryptocurrency

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eToro is a publishing partner of CoinGecko

The European Central Bank and the People’s Bank of China are leading the way in creating their respective digital euro and digital yuan. Studies and tests are being carried out as we speak to turn this progressive idea into reality. In fact, China is aiming to have its digital yuan operational by 2022, as the government intends to ultimately replace its physical currency with a digital one.

What is a Central Bank Digital Currency?

A central bank digital currency (CBDC) is a monetary value that’s stored electronically. It’s a liability of the central bank and can be used to make payments. Essentially, it’s a digital representation of the fiat currency backed by monetary reserves like gold. As the name suggests, CBDCs are centralized, meaning they are issued and regulated by the monetary authority of the country.

On the other hand, cryptocurrency is a digital representation of value that is not issued by central banks or institutions and instead uses cryptographic proof for the verification process. Cryptocurrencies, like Bitcoin, can be used as an alternative to fiat currency (e.g., the US dollar). Instead of accessing a bank, cryptocurrencies like Bitcoin can be purchased on exchanges like eToro, where users can choose to buy, hold, and trade their investments, similar to other capital markets.

What's the main difference between CBDC and Cryptocurrency?

They may be on a similar wavelength, as both CBDCs and cryptocurrencies are forms of digital currencies. However, what differentiates the two most of all is how they are issued. A CBDC is issued centrally (i.e., by a central bank) while cryptocurrency is created by users via a peer-to-peer system.

A digital euro, for example, can only be issued by the European Central Bank as it is a digital representation of the fiat currency. So its value would be similar to that of the Euro as we know today, only that it is distributed digitally and may be created on blockchain technology.

Cryptocurrency’s value is determined by the supply and demand of the market and is not backed by a legal entity. However, certain cryptocurrencies such as Libra (now Diem)  can be backed by corporations (in this example, Facebook). This does not undermine the fact that it’s mined by users, and not printed by a central bank.

Privacy and Self Custody

Cryptocurrency is known for giving users the freedom to own their assets fully and allows them to transact beyond borders without going through a regulatory body of a country. This means that data can be expressed at any amount without limitation and regulation.

This idea of self custody and data privacy, which are boldly upheld by cryptocurrencies, are less likely to be emphasized by CBDCs. The reason is that central banks are adjoined with the tax authorities that demand user data and enforce anti-money laundering provisions among other regulations.

Even so, CBDC aims to marry the convenience and security of digital currency with the regulated reserve-backed money of the traditional banking system.

It’s worth noting that demand for privacy does not imply any involvement in criminal activities. Law-abiding citizens also seek privacy to keep them safe from malicious threats.

Security

With cryptocurrency, security is at the forefront of what the community is trying to achieve. Despite having gone through some notable cyber threats, such as 51% attacks on blockchains, cryptos have impressively scaled so much over the years, and the attacks help illustrate how blockchains are battle-tested.

On the other hand, CBDCs are vulnerable to an even larger surface of attack, as they have not overcome issues like setbacks in operating technology or exchange security failure. Central banks are also still struggling with protections for their current paper currency, which has been going on for centuries. Rival states and financially-motivated hackers have repeatedly found centralized points of failure within central banks, carrying large consequences.

Difference in Goals

When Bitcoin was created in 2008 as a reaction to the financial crisis, it provided a way for consumers to escape the traditional banking system and hedge against losing spending power in cash due to inflation. It allowed users to avoid conventional control from central banks by offering a decentralized and distributed form of money.

CBDC values are largely the opposite of those held by cryptocurrencies. Despite the promise of convenience and security, CBDCs strive to preserve the oligopoly of the global banking system, instead of democratizing financial systems.

Similarity Between CBDC and Cryptocurrency

Differences aside, there is indeed at least one similarity between central bank digital currency and cryptocurrency. As we know, cryptocurrency thrives on blockchain technology. Similarly, CBDC hopes to use blockchain technology to create a new way of payment that is easier and more cost-effective.

Can They Work Together?

Due to the difference in values, CBDC and cryptocurrency seem to be more competitive than collaborative. One offers a secure yet centralized form of monetary exchange, while the other seeks a more democratic approach to the financial system.

It’s no coincidence that the interest in creating CBDCs is driven by the rapid maturity of the crypto market. Central banks have been anticipating potential threats with Bitcoin, which has seemingly increased with Facebook announcing their own cryptocurrency, along with other mainstream adoptions in big tech. Facebook’s cryptocurrency may see a higher adoption rate than Bitcoin due to its existing 2 billion users.

The future of our financial system, be it centralized or decentralized, depends on us users. What do we value? What do we want to see? We’re in the midst of a new financial era and we hope that this information may help guide you to support an approach to finance that benefits you.

eToro is a publishing partner of CoinGecko

eToro USA LLC; Investments are subject to market risk, including the possible loss of principal. 

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