The introduction of new forms of money such as central bank digital currency or CBDC has been responsible for shifting the dynamics in the financial ecosystem. As a digital variant of central bank money, CBDC has turned into a new age solution for a cashless society. Although there are various reasons to consider the adoption of CBDCs, it has been primarily promoted as a blockchain solution i.e. CBDC blockchain for the rising dominance of tech giants in the digital currency landscape.

So, why should you worry about CBDC blockchain solutions? Is it reasonable to bring blockchain into the equation with CBDCs? On the other hand, anyone could wander about the potential reasons for which one would consider using blockchain for CBDCs. The following discussion aims to provide you with a detailed impression of how far it is reasonable to go with blockchain solutions for central bank digital currencies. 

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Defining CBDC and the Role of Blockchain in CBDCs

One of the first factors about central bank digital currency blockchain solutions is the definition of CBDCs. Central bank digital currency or CBDC provides digital forms of central bank money to provide unique advantages for central banks in retail and wholesale perspectives. Some of the notable functionalities of CBDCs include improved infrastructure for interbank settlements or better financial inclusion for individual customers.

CBDC basically works as a legal tender and also enjoys the backing of a central bank. Interestingly, CBDC represents a claim against the concerned central bank rather than a Payment Service Provider or a commercial bank. Generally, you have to maintain a CBDC on a digital ledger that could be either blockchain-based or not.

The digital ledger should support the speed of payments between banks, individuals, and institutions with the assurance of better security. A recent study by the Bank for International Settlements (BIS) presented favorable prospects for considering CBDC blockchain solutions. The findings of the study clearly indicate that over 70% of institutions are presently engaged in active research and development of proofs of concept for central bank digital currencies. 

Traits of Central Bank Digital Currency

It is highly crucial to establish a clear impression of essential aspects of central bank digital currency before diving into CBDC blockchain solutions. The first important characteristic of central bank digital currency refers to its digital nature. CBDCs are basically considered as digital assets and are accounted for in a digital ledger. The digital ledger serves as the single source of truth for CBDCs.

The next crucial trait in CBDCs refers to the backing of a central bank, as CBDC provides a representation of claims against central bank, like banknotes. Another notable highlight that you can find in CBDCs refers to the control of central banks over them. The concerned central bank issuing CBDCs takes full control over the supply of CBDCs and determining the requirement for supply. 

Central Bank Digital Currency Use Cases

Now, it is important to reflect on the use cases of CBDCs to find out the feasibility of central bank digital currency blockchain solutions. The use cases of CBDCs are largely focused on retail or wholesale payments. You can assume retail CBDC as the digital variant of cash. On the other hand, wholesale CBDC points out towards a completely new infrastructure to facilitate interbank settlements.

The primary objectives of central banks in different use cases of CBDCs also play an important role in understanding CBDC blockchain solutions. Regardless of the use case, central banks want to achieve faster payments with lower costs and overheads through CBDCs. The retail CBDC is a suitable alternative for transactions between individuals and businesses as well as other individuals. It would be just like making transactions in digital banknotes.

The overall volume for retail CBDC transactions is generally more than 100,000,000 every day. On the other hand, wholesale CBDC is suitable for ensuring efficient interbank settlements. Interbank settlements generally refer to the transactions between selected banks and other entities having accounts in the concerned central bank. The overall volume of wholesale CBDC transactions is generally less than 100,000 on a daily basis. 

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Understanding the Positive Aspects of CBDCs

Before moving towards central bank digital currency blockchain solutions, it is important to focus on the benefits of CBDC. The financial infrastructure of central banks faces various problems in the existing scenarios. Some of the notable issues include reduced usage of banknotes, restrictions on financial access for citizens away from the bank branches, and higher costs in payment settlements.

Estimates suggest that the overall cost of clearing and settling securities across central banks in G7 countries crosses $50 billion annually. The most prominent reason for such high costs for clearing and settlement of securities for central banks refers to the requirement of resources for transferring assets and reconciliation of accounts.

In addition, the modern cross-border payment systems allow the transfer of assets alongside crucial transaction data across various correspondent banks. As a result, individuals, as well as institutions, are liable to experience higher vulnerability to settlement and operational risks. This is where CBDC blockchain solutions serve a promising answer because blockchain-based CBDCs can address the inefficiencies and vulnerabilities in existing central banking infrastructure.

Blockchain can ensure the simpler development of a secure payments system. At the same time, it can also serve the functionalities of a large-scale asset register and decentralized clearinghouse. Now, let us reflect on the advantages that you can explore with the two common types of CBDCs. 

  • Advantages of Retail CBDC

Retail CBDC can help in ensuring important benefits of availability, streamlined reconciliation, improved monetary policy, and improved digital innovation. The retail CBDC blockchain solutions can provide better availability as it can be distributed on mobile devices with increased access for citizens.

As a result, citizens who are far away from bank branches without access to physical cash can have better inclusion in the financial ecosystem. Retail CBDC solutions can also provide streamlined reconciliation due to their natively digital nature. Retail CBDCs don’t require time-consuming reconciliation with additional costs that are found commonly in cross-border and e-commerce payments.

The platform-based software model in retail CBDC solutions can promote innovation by reducing barriers for entry to new firms in the payments sector. The arrival of new firms can promote competition as well as innovation alongside driving financial institutions to achieve globalization of services.

Retail central bank digital currency blockchain solutions can also offer privileges to banks for exerting direct influence on the money supply. The influence can help in simplifying the allocation of government benefits for individuals. At the same time, it also allows opportunities for improving control on transactions to facilitate tax controls. 

  • Advantages of Wholesale CBDC 

Wholesale CBDC blockchain solutions are capable of providing benefits of improving interbank settlement of payments, participation in digital asset markets, reduced counterparty risk, and sustainability of competitive advantage. The automation and decentralized netting solutions can enable install settlement of CBDC payments among counterparties according to individual orders.

As a result, the wholesale CBDC solutions can reduce the risks of collateralization and overnight batch processing. CBDC solutions also offer a massive, decentralized clearing house as well as an asset register for speeding up the digital assets revolution. Central bank digital currency blockchain solutions on the wholesale level can offer a reliable solution for tokenized payments with the rising tokenized asset markets.

Wholesale CBDC solutions can also provide a better reduction of credit risk for cross-border payment transactions. Wholesale CBDCs can offer the facility for activating a payment-versus-payment settlement model to facilitate transfers in terms of different currencies.

The final and most important contribution of wholesale CBDC solutions to the existing financial ecosystem points towards sustained competitive advantage. Centralized platforms such as SEPA in Europe have been helpful for reducing the cost of real-time money transfers.

However, the majority of financial institutions continue to overprice their transfer costs for customers. With the help of wholesale CBDC blockchain solutions, end-users could access a streamlined banking infrastructure. In addition, CBDC solutions can also ensure that central banks continue their role in interbank settlement while catering to the growth in the adoption of stablecoins. 

Reasons to Choose Blockchain for CBDC 

After a detailed reflection on the potential of CBDC and the validity of the central bank digital currency blockchain relationship through the digital ledger connection, it is important to find why blockchain is suitable for CBDC. Blockchain technology can introduce many promising advantages in the domain of CBDCs. One of the most popular production-ready blockchain environments for supporting CBDC requirements of privacy and scalability is Ethereum. Let us take a look at some of the reasons validating the use of CBDC blockchain solutions.

  • Advantage of System Trust 

First of all, blockchain brings the element of system trust in CBDC. In the case of a CBDC blockchain solution, central banks have the authority over controlling currency and offering safeguards for privacy and independence in the use of CBDC by end-users.

The system trust factor added by blockchain in CBDCs ensures that users don’t have to depend on intermediaries. Most important of all, users could avoid any concerns of lock-in by intermediaries. Therefore, central bank digital currency blockchain solutions offer the assurance of trust in using CBDCs as alternative forms of payment. 

  • Programmability in Blockchain

The second important reason to consider the application of blockchain technology in CBDCs is programmability. Central bank digital currency blockchain solutions can have the CBDC rules hardwired in the protocol of CBDC. As a result, users can take care of compliance without even having to worry about it.

For example, blockchain-based CBDCs can offer third-party access to the system alongside establishing wallet thresholds. Therefore, it is possible to leverage blockchain technology for developing CBDC solutions according to specific requirements of concerned central banks. 

  • Availability of Data

The next crucial factor that promotes the use of central bank digital currency blockchain solutions is data availability. Since blockchain is a distributed system, it can provide the assurance of better data availability and resilience. At the same time, blockchain can also offer better trust and transparency regarding the transaction history.

Therefore, you wouldn’t have to face any issues in monitoring and evaluating the transactions with CBDCs by leveraging blockchain technology. Furthermore, Ethereum has also showcased its capabilities for supporting extremely massive networks having more than 10,000 nodes.

With support for hundreds of thousands of users, Ethereum is capable of providing a formidable guarantee of unwavering data availability. Therefore, CBDC blockchain solutions can help in facilitating transactions among a wide variety of users on a given network. 

  • Opportunities for Innovation

The final entry among the top reasons to choose blockchain for CBDC development refers to innovation. Blockchain-based CBDC solutions can gain promising improvements by capitalizing on the new advancements emerging throughout the open-source blockchain landscape.

Some of the examples of innovative products and services in a blockchain ecosystem that can improve CBDC blockchain solutions include decentralized finance, non-custodial wallets, and zero-knowledge cryptography. The integration of these new functionalities in the world of central bank digital currencies can spell new improvements for CBDCs.

Apart from offering better functionalities for users, blockchain-based CBDC solutions can also introduce performance advantages. The Ethereum blockchain ecosystem presently includes more than 350,000 developers with unique ideas and insights. The prospects of continuous innovation can also boost the functionalities of central bank digital currency blockchain solutions in the future.

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Challenges for Blockchain-based CBDC

Although the prospects for adopting blockchain in CBDC solutions have increased substantially in recent times, it is important to focus on the challenges. The prominent challenges would emerge, particularly in end-to-end propositions for the development of CBDC blockchain solutions.

In addition, it is also important to consider the wider implications associated with the development of blockchain-based CBDCs. For example, the implications for the wider financial system, commercial bank deposits, and legal implications can influence the development of blockchain-based CBDCs.

Final Words

On a concluding note, it is clear that blockchain-based CBDC solutions can introduce promising improvements in CBDC infrastructure. Most important of all, blockchain-based CBDC could provide assurance of security, availability, accessibility, and transparency of transactions. By leveraging the fundamental traits of blockchain, it is possible to bring CBDC blockchain solutions to the forefront of the existing financial ecosystem.

With the constantly rising attention on central bank digital currency blockchain solutions, it is reasonable to explore the scope of CBDCs. In addition, it is also important to find alignment between blockchain and CBDC features for achieving the perfect combination. Enroll in the CBDC online course and explore more about CBDCs and their equation with blockchain right now!