October 31, 2022 was a special day for crypto enthusiasts. Bitcoin maximalists were celebrating the 14th anniversary of its white paper.
Incidentally, the same day, the Reserve Bank of India (RBI) announced the first pilot of the Digital Rupee - Wholesale segment (e₹-W) as part of its central bank digital currency (CBDC) project, starting from November 1, 2022.
To those not well versed with digital currency technology, cryptocurrency and CBDC might seem one and the same. But they aren’t. Here’s demystifying the two.
Definition: CBDC And Crypto
To start with, CBDC refers to the digital form of a country’s fiat currency, which is issued by the central bank of the country. Though it is in a digital form, it can be exchanged with the fiat currency of the country. This money is a liability of the central bank. Transactions are recorded in a centralised ledger and central banks retain full control over its supply. CBDC has the same value as that of the country’s physical fiat currency (notes or coins).
Cryptocurrency, on the other hand, is a digital money created to function as a means of exchange. In addition to controlling the production of new units of a certain digital currency, it uses encryption to safeguard and verify transactions.
Cryptocurrency Vs CBDC
Cryptocurrencies are independent digital currencies that run on the principle of decentralisation and without predetermined value or backing. Bitcoin (BTC) and Ethereum (ETH) are examples of such cryptocurrencies.
In contrast, CBDC has the backing of central banks. For example, the RBI has given the name of its CBDC as “Digital Rupee”. China’s proposed CBDC is digital yuan (e-CNY).
There are some cryptocurrencies, which are known as Stablecoins that are pegged to the dollar, but backed by private entities. Examples would be Tether (USDT), USD Coin (USDC) and Facebook-backed Diem (earlier known as Libra).
Another difference is that while cryptocurrencies use a permission-less open network, CBDCs use a private Blockchain network that has prior permission.
Also, when users transact on the network using cryptocurrencies, they remain anonymous. However, CBDCs will be linked to an individual’s bank account, which will have their personal data.
Most importantly, CBDCs are managed by a central authority, making network scalability simpler.
In comparison, any changes to the cryptocurrency network must be approved by all nodes in the network. When the network has to scale, but the nodes disagree on how to proceed, this could lead to a problem.