Central Bank Digital Currency (CBDC) is a government-backed digital form of fiat currency. Issued and regulated by a central bank, CBDC is pegged to the nation’s official currency. Although it shares similarities with stablecoins—a type of virtual currency—the key distinction is that CBDC is issued and controlled by the government. In other words, CBDC is a centralized digital currency rather than a decentralized cryptocurrency.
Over 114 countries, representing 95% of global GDP, are currently researching or developing CBDCs. Several nations have already launched their own digital currencies. It is highly likely that CBDCs will become part of our daily lives in the near future.
This article explains what a CBDC is, its benefits and risks, and how it differs from cryptocurrencies.
What Is a Central Bank Digital Currency (CBDC)?
Central Bank Digital Currency (CBDC): A digital form of national currency supported and issued by a central bank.
A CBDC is a digital version of a country’s legal tender. Fiat currencies like the US dollar or the New Taiwan Dollar exist in physical forms such as banknotes and coins and are used for transactions involving goods and services.
CBDC serves as the digital equivalent of these physical currencies. It carries the full trust and backing of the issuing government, just like traditional money. If a country adopts a CBDC, users should be able to utilize it for payments, remittances, and other financial activities without risk.
CBDCs can be built on blockchain technology or other forms of distributed ledger technology (DLT). If blockchain is used, the system requires blocks, miners, and nodes to function properly, which may result in higher maintenance costs compared to alternative DLT solutions. Therefore, sustainability and operational costs are important considerations for central banks.
Imagine a CBDC as having an account directly with the central bank. All funds would represent liabilities of the central bank, reducing concerns about financial risks within the commercial banking system.
Why Are Central Banks Interested in CBDCs?
CBDCs aim to provide users with convenient and secure digital payment methods while maintaining regulatory oversight and reserve-backed liquidity.
Key reasons central banks are exploring CBDCs include:
- Cost Efficiency: CBDCs can be more cost-effective than physical cash since digital transactions typically incur lower costs. They can also help streamline national payment systems.
- Financial Inclusion: CBDCs can offer unbanked populations easier and safer access to financial services via mobile devices. For example, approximately 5% of Americans do not have a bank account, and another 20% rely on costly financial services like money orders or payday loans. CBDCs could make financial services more affordable and accessible.
- Monetary Policy Effectiveness: CBDCs could enable more direct and efficient implementation of monetary policies. For instance, the U.S. Federal Reserve currently influences the economy indirectly by adjusting interest rates. With a CBDC, the central bank could interact directly with citizens, potentially increasing the impact of its policies.
Additional motivations may include combating financial crime, though this often raises privacy concerns that must be carefully addressed.
Is Issuing a CBDC Equivalent to Printing Money?
No. A CBDC does not constitute new money creation. It is simply a different representation of existing currency. The fundamental principles governing money supply and monetary policy remain unchanged.
Types of CBDCs
CBDCs can be categorized into two primary types:
1. Retail CBDC (General Purpose)
Retail CBDCs are designed for daily use by the general public, much like physical cash. They facilitate small-scale transactions and consumer payments.
2. Wholesale CBDC
Wholesale CBDCs are restricted to financial institutions for large-value settlements, such as interbank transfers and securities transactions. These digital currencies can incorporate programmable features, enabling automated and conditional payments, which can enhance the speed and reliability of cross-border transactions.
The following table compares traditional central bank money with CBDCs:
| Aspect | Cash | Central Bank Reserves | Retail CBDC | Wholesale CBDC |
|---|---|---|---|---|
| Usage Scenario | Retail | Wholesale | Retail | Wholesale |
| Form | Physical | Digital | Digital | Digital |
| Transfer Mechanism | Physical | Digital | Digital | Tokenized |
| Operating Hours | 24/7 | Limited | 24/7 | Can be designed for 24/7 use |
| Offline Capability | Yes | No | Possible | No |
How Do CBDCs Work?
The operational structure of a CBDC can vary by country. One common model, proposed by the Bank of England, involves a centralized technical infrastructure (such as a DLT platform) managed by the central bank. This platform would connect private payment service providers with end-users, under the regulatory supervision of the central bank.
This structure is typically associated with retail CBDCs and aims to ensure security, efficiency, and interoperability.
Advantages and Disadvantages of CBDCs
The primary advantage of CBDCs is the potential to reduce transaction costs and improve banking services. However, their centralized nature raises significant concerns.
Advantages of CBDCs
- Improves the efficiency of monetary policy implementation
- Increases liquidity in payment systems
- Reduces cross-border payment costs
- Enhances privacy by limiting personal data exposure to private companies
- Helps prevent illegal activities
CBDCs can streamline government functions such as welfare distribution and tax collection. They can also integrate disparate payment systems, improving interoperability.
From a privacy perspective, CBDCs could reduce the amount of personal data collected by private payment processors. Additionally, the use of cryptographic techniques and transparent ledgers could help central banks track transactions and deter financial crimes.
For international transactions, which currently average around 5.41% in fees from the U.S. to other countries, CBDCs could significantly lower costs and increase settlement speed.
Risks and Disadvantages of CBDCs
- Central banks gain substantial control over transactions
- Could disrupt the existing banking system
- Raises privacy concerns due to increased surveillance capabilities
- Adoption may be slow due to public skepticism
- Potential competition between central banks and commercial banks
- Risk of bank runs during financial crises
The centralized control of CBDCs means that central banks could monitor all transactions, creating potential privacy issues. Furthermore, if consumers shift their holdings to CBDCs, commercial banks may see a reduction in deposits, affecting their ability to lend.
In times of economic uncertainty, people might prefer holding CBDCs over bank deposits, fearing bank insolvency. This could trigger bank runs and destabilize the financial system.
How Do CBDCs Differ from Cryptocurrencies?
Although both are digital, CBDCs and cryptocurrencies are fundamentally different.
The core distinction lies in centralization. Cryptocurrencies are decentralized and typically operate on public blockchains, offering a degree of anonymity. CBDCs, by contrast, are centralized and government-controlled, with the central bank maintaining a record of all transactions.
Below is a comparison:
| Aspect | CBDC | Cryptocurrency |
|---|---|---|
| Issuer | Government/Central Bank | Private entities/Decentralized community |
| Centralization | Centralized | Decentralized |
| Supply Control | Unlimited (managed by central bank) | Often capped (e.g., Bitcoin) |
| Key Features | Government-backed, regulated | Borderless, pseudonymous, permissionless |
Global CBDC Development Status
According to the Central Bank Digital Currency Tracker, only 35 countries were considering CBDCs in 2020. By the end of 2022, that number had grown to 114.
As of early 2023:
- Launched: 11 countries, including Nigeria and several in the Eastern Caribbean.
- Pilot Stage: 17 countries, including China, South Korea, and Russia.
- Development Stage: 33 countries, including the U.S., Canada, Japan, and Taiwan.
- Research Stage: 39 countries, including Mexico and New Zealand.
- Inactive: 15 countries.
- Canceled: 2 countries.
Developed economies like the U.S., Canada, and many European nations are still in the development phase, while some emerging economies have already launched their digital currencies.
CBDC Development in Taiwan
Taiwan completed a wholesale CBDC feasibility study in June 2020, concluding that current DLT solutions could not yet handle real-time, high-volume transactions efficiently. A retail CBDC trial was completed in September 2022, and the country is currently in the development stage.
Challenges for the U.S. CBDC
The U.S. Federal Reserve is still exploring the potential of a digital dollar. Key challenges include:
- Privacy: Balancing individual privacy with the need to prevent illicit activities.
- Intermediation: U.S. law prevents individuals from holding accounts directly with the Fed, requiring intermediary institutions.
- Transferability: Ensuring the digital dollar can be easily integrated with existing and future payment systems.
These issues are among the reasons why CBDC implementation in developed nations has been cautious.
Case Study: The Bahamas’ Sand Dollar
The Bahamas was one of the first countries to launch a CBDC, known as the Sand Dollar. The project started in December 2019 and was rolled out nationally in October 2020.
For countries with underdeveloped financial infrastructure, CBDCs offer a way to reduce the cost of cash circulation and improve financial inclusion. In more developed economies, however, the role of a CBDC must be carefully evaluated to avoid disrupting existing efficient systems.
Key Takeaways: Understanding CBDCs
- A CBDC is a digital form of national currency issued and backed by a central bank.
- CBDCs can be retail-oriented (for the general public) or wholesale-oriented (for financial institutions).
- Over 110 countries are currently exploring CBDCs.
- CBDCs can lower transaction costs and improve financial inclusion but raise concerns about privacy and centralization.
- The main difference between CBDCs and cryptocurrencies is that the former is centralized and government-issued, while the latter is decentralized and community-driven.
Frequently Asked Questions (FAQ)
What is the main purpose of a CBDC?
CBDCs aim to modernize the financial system by offering a secure, government-backed digital currency. They can reduce transaction costs, improve payment efficiency, and increase financial inclusion.
Can CBDC replace physical cash?
It is unlikely that CBDCs will completely replace cash in the near future. Instead, they are expected to coexist with physical money and other forms of digital payment.
Is CBDC a cryptocurrency?
No. Although both are digital, CBDCs are centralized and issued by governments, while cryptocurrencies are decentralized and not controlled by any single entity.
How does CBDC affect privacy?
CBDCs could enhance privacy by reducing the role of data-collecting private intermediaries. However, because the central bank can monitor all transactions, there are concerns about potential surveillance.
Which countries have successfully launched a CBDC?
Several countries, including the Bahamas, Nigeria, and some Eastern Caribbean states, have fully launched CBDCs. Larger economies are proceeding more cautiously.
Are CBDCs safe?
CBDCs are backed by central banks, making them very secure. However, like all digital systems, they could be vulnerable to cyber threats. 👉 Explore real-time security tools
Conclusion
CBDCs represent a significant evolution in the history of money. While they offer numerous benefits—including efficiency, financial inclusion, and reduced costs—they also introduce new risks and challenges.
No major economy has fully implemented a retail CBDC yet, so many questions remain unanswered. Nevertheless, understanding the fundamentals of CBDCs is essential as they may soon become a reality in many parts of the world.
For those interested in staying updated on digital currency trends, it is important to follow reliable sources and continue learning about the evolving landscape of money and payments. 👉 Get advanced learning methods