Understanding the Types of Central Bank Digital Currencies (CBDC)

Understanding the Types of Central Bank Digital Currencies (CBDC)

By bit.team

The formidable revolutionary changes in the world of financial services that have taken place in recent years have completely changed the generally accepted ideas. The impact of digital transformation on financial services has not been limited to changing the platform for providing services. On the contrary, many technological advances over the past years have changed our traditional views on financial services.

Now the blockchain provides flexible access to highly reliable, transparent and faster financial services. Following this trend, central banks are also evaluating the types of CBDC to find out the possibilities of issuing their own digital currencies in the future. Interest in digital currencies of central banks is growing due to a number of factors.

A brief review of the CBDC

One of the main difficulties in understanding the types of CBDC (digital currencies of the central bank) is the lack of a clear definition. CBDCs do not have any specific definition, and can point to different directions depending on the perception of the audience. The most common explanation for the digital currencies of central banks is that they represent a new version of money.

Thus, you can consider them as a digital currency with the obligations of the central bank, having a nominal value in the existing unit of account. Digital currency can serve as a means of saving, as well as a means of exchange.

The Bank of England gives a clearer definition of CBDCs, calling them electronic money of the central bank. In addition, the Bank of England also points out some important features of them, such as:

  • CBDCs are more affordable compared to reserves.
  • They offer improved support for retail transactions compared to cash.
  • They will have a different operational structure compared to various forms of money.
  • They can also generate interest in the case of realistic assumptions about the payment of an interest rate other than reserve rates.

Another interesting aspect of the CBDC definition related to the asset architecture shows the possibilities for different categories. Obviously, this is an electronic form of central bank money. At the same time, it is important to note that it can belong to both financial institutions and the population. Depending on these two principles, you can find two different models that establish their classification.

Various CBDC categories

The discussion of CBDC types will eventually focus on two different models of digital currencies of the Central Bank. The first model is called a retail CBDC, and the second is called a wholesale one. Let’s reflect on these two models to understand these types of Central Bank currencies in detail.

CBDC Retail Model

The retail model of CBDC is usually focused on ensuring payments between legal entities and individuals. This type of asset architecture clearly shows a low cost, although with a large volume. In addition, the retail model flexibly follows the use of various payment instruments.

Even if cash is the usual payment method, various retail payments are still finding possible ways to perform through cards, as well as online transfers. The organization of electronic retail payment systems around the world has a lot in common. Their general structure includes three different processes, such as the clearing, settlement and transaction process.

The transaction process includes sending and delivering payment instructions. The transaction process also focuses on verifying and authenticating the sender of the transaction and the recipient. In addition, it also focuses on verifying payment instructions.

In the clearing process, special attention is paid to the comparison and processing of payment data. In addition, the most important function of retail electronic payments in this process is the calculation of claims and settlement obligations. In addition, the clearing process also ensures the proper transfer of payment data to the settlement agent.

The settlement process is the latest addition to the retail payment model, which ensures mutual settlements by the relevant parties, with subsequent necessary checks. After the settlement process, all relevant parties receive a confirmation of the credit or debit.

All this leads to serious problems that require the introduction of retail types of CBDC. They can be made available to the general public in two different forms, such as digitally issued tokens and deposit accounts with the central bank.

As for deposit accounts, legal entities and individuals can open accounts with the relevant central bank, as well as enjoy the benefits of similar services of commercial banks.

Using deposit accounts, users can initiate and receive transactions, as well as view their account balance. Other types of CBDC in the retail model include CBDC tokens issued digitally. Tokens issued in digital form are an electronic alternative to coins and banknotes. Only the central bank has the right to issue these tokens to commercial banks for distribution. And even if they appear in the rating Coinmarketrate.com this does not mean that they belong to cryptocurrencies. On the contrary, it is their complete opposite.

Types of Retail CBDCs

The main feature of both types of CBDC in the retail model indicates a difference in the verification required for use. The Central Bank tokens must pass authentication, for example, information about the history of expenses. CBDC deposit accounts will require verification of the account holder, for example, KYC procedures. Let’s take a look at some of the notable varieties of retail CBDC.

Indirect CBDC Retail

Indirect retail CBDC is one of the most common types of digital currencies of the Central Bank, which is very similar to the existing retail payment processes. You will need an intermediate level of financial institutions to create an indirect retail CBDC. Such intermediaries take care of connecting and interacting with legal entities and individuals, as well as sending payment messages to financial institutions.

Direct retail trade

Direct retail sales solutions are aimed at legal entities and individuals who own the token by attracting private accounts with the central bank. Therefore, intermediaries are not needed for direct retail sales of CBDC.

The Central Bank is responsible for connecting and managing financial services. However, new developments in the direct retail CBDC model will help attract intermediaries among users and central banks.

Hybrid Retail

CBDC Hybrid Retail offers a combination of indirect and direct retail options. You can find an intermediate level of financial institutions in CBDC hybrid retail. However, individuals and businesses may have a direct right to claim a CBDC with the relevant central bank. One of the important consequences of this scenario is that intermediaries can support the separation of CBDC from balance sheets. As a result, businesses and individuals could get more profit.

Wholesale Model

The second broader classification of the CBDC architecture brings us to the wholesale token model. The wholesale trade model can simplify payments along with settlements for transactions between financial institutions. Now it is important to note that banks are already using the possibility of direct access to the central bank’s electronic money.

On the other hand, wholesale asset types can offer improvements in risk management and the efficiency of the settlement process. In addition, the wholesale CBDC is also applicable for transfers of securities-related assets. You can detect two wholesale CBDC types according to their implementations.

Internal payments

Most wholesale transactions are currently associated with high cost, shorter settlement times and institutional participants. Wholesale transactions of systemic importance can be carried out, as a rule, through central banks working with real-time gross settlement systems (RTGS), which are responsible for making these payments.

The example of two European payment systems, such as EURO1 and TARGET2, demonstrates the use of wholesale CBDC types. TARGET2 is owned and under the operational control of the European Union. Internal payments in TARGET2 usually begin with the issuing of payment instructions by the sending bank to the recipient’s bank.

Then the system will complete the reconciliation, confirmation and, finally, the completion of the transaction, ensuring the transfer of funds between bank accounts. The internal wholesale CBDC will function in the same way, with a particular focus on areas that require faster, more reliable and valuable internal payments with security.

International payments

The option of using wholesale CBDCs for cross-border payments is more important than domestic wholesale CBDCs. Currently, cross-border transactions depend on various intermediaries along with jurisdictions related to one-time payments.

To solve the isuues of cross-border transactions, wholesale CBDCs can be created in three different scenarios. You can have local, local transferable, and universal wholesale CBDCs.

In addition to classifying wholesale CBDC types for domestic and international payments, you can also find wholesale CBDC types for secure transactions. These types of CBDCs can play a huge role in supporting tokenization and digital transformation of the security value chain.

Summing uo

The most important aspect to pay attention to in the case of various types of CBDC concerns their value advantage. CBDCs open up opportunities for simpler, faster and more efficient transactions, regardless of geography.

In addition, CBDCs have the inherent advantages of various features of blockchain technology. Studying different CBDC variants clearly shows how one simple concept can be implemented using different models.

But one should understand  that the above is just a technical description of the concept itself. All the advantages of this concept are aimed at replacing, with the subsequent complete displacement and liquidation of cryptocurrencies, possibly including Bitcoin.

A striking example of the use of Central Bank currencies is the digital yuan in China. Here is an example of how blockchain and digitalization can become a weapon of total control.