What Is Central Bank Digital Currency (CBDC)?
A Central bank digital currency (CBDC) is a digital form of a country's fiat money that is issued and backed by its central banks. Unlike the digital money held in commercial bank accounts, a CBDC represents a direct liability of the central bank, similar to physical cash58, 59. It falls under the broader category of Monetary Policy & Digital Finance, aiming to modernize payment systems and provide a digital equivalent to banknotes and coins56, 57. This digital form would enable the general public to make digital payments directly using central bank money, offering a safe and efficient means of exchange54, 55.
History and Origin
The concept of digital money has evolved significantly, leading central banks worldwide to explore the possibilities of a central bank digital currency. While digital payments have been widespread for years, the idea of a central bank directly issuing digital currency gained traction as economies became increasingly digital and the use of physical cash declined52, 53. The European Central Bank (ECB), for instance, began its exploration of a digital euro in October 2020 with a comprehensive report, followed by a public consultation, and launched its preparatory phase in October 202350, 51. Similarly, the Federal Reserve in the United States released a discussion paper in January 2022 to examine the pros and cons of a potential U.S. CBDC48, 49. These initiatives reflect a global trend where over 120 jurisdictions were evaluating national digital currencies as of 2023, with some countries and regional unions having already launched pilot programs or full CBDCs47. The Bank for International Settlements (BIS) has also been instrumental in fostering international cooperation and research into CBDCs through various projects44, 45, 46.
Key Takeaways
- A CBDC is a digital form of currency issued directly by a central bank, making it a direct liability of the state.
- It is designed to be a secure and efficient means of payment, complementing existing cash and commercial bank deposits.
- CBDCs aim to enhance financial inclusion by providing access to digital payments for underserved populations40, 41, 42, 43.
- They could modernize domestic and cross-border payment systems, potentially reducing costs and increasing speed37, 38, 39.
- The development and implementation of CBDCs involve complex policy and technical considerations, including privacy, cybersecurity, and financial stability implications.
Interpreting the Central Bank Digital Currency
A central bank digital currency (CBDC) is interpreted as a digital equivalent of physical cash, carrying the full faith and credit of the issuing central bank. This means that unlike funds held in commercial banks, a CBDC would not be subject to bank-specific credit risk or liquidity risk36. The interpretation of a CBDC emphasizes its role as a stable and secure digital asset, providing a public option in an increasingly digital financial landscape35. It is seen as a way to ensure the public's access to central bank money even as the use of physical cash declines, maintaining trust in the overall payment systems34.
Hypothetical Example
Imagine a country, "Diversifica," introduces its own CBDC, the "DiversiCoin." Sarah wants to buy groceries from a local market. Instead of paying with physical cash or a traditional debit card linked to her commercial bank account, she uses her digital wallet app, which holds DiversiCoins directly issued by Diversifica's central bank. When she makes the purchase, the DiversiCoins are instantly transferred from her digital wallet to the merchant's digital wallet. This transaction is settled directly on the central bank's ledger, ensuring immediate finality and removing the need for intermediary commercial banks for this specific type of payment. The DiversiCoin, being a form of legal tender, is accepted universally throughout Diversifica, just like its physical banknotes.
Practical Applications
Central bank digital currencies show up in various aspects of modern finance and economic planning. Their primary application is to enhance the efficiency and resilience of national payment systems, particularly for retail transactions33. A CBDC could facilitate faster, cheaper, and more inclusive cross-border payments, addressing current inefficiencies in international transfers31, 32. From a monetary policy perspective, a CBDC might offer central banks new tools for policy implementation, though this area requires careful study to avoid unintended consequences for financial markets and interest rates29, 30. Furthermore, a CBDC has the potential to boost financial inclusion by providing a public digital payment option to populations without access to traditional banking services27, 28. The International Monetary Fund (IMF) has highlighted these potential benefits, including greater efficiency and lower costs, alongside the opportunity to counter the rise of private digital currencies26.
Limitations and Criticisms
Despite the potential benefits, central bank digital currencies face several limitations and criticisms. A significant concern is the potential for disintermediation of commercial banks, where large-scale shifts of deposits from banks to CBDCs could reduce bank funding and impact their ability to extend credit23, 24, 25. This could lead to banks raising deposit rates to attract funds, potentially affecting lending rates and overall financial stability22.
Another major criticism revolves around privacy. While some CBDC designs, like the digital euro, emphasize high privacy standards by separating identity from payment data, concerns persist about potential government surveillance or control over transactions20, 21. Operational challenges, including cybersecurity risks, system glitches, and the costs of developing and maintaining a robust CBDC infrastructure, also present significant hurdles and reputational risks for central banks17, 18, 19. In the United States, legislative efforts, such as the Anti-CBDC Surveillance State Act, reflect concerns about potential government overreach and prohibit the Federal Reserve from issuing a digital dollar without Congressional authorization15, 16. The Center for European Policy Analysis highlights this transatlantic divergence, noting European embrace of CBDCs for their perceived stability and privacy features, contrasted with U.S. concerns about potential government control14.
Central Bank Digital Currency vs. Cryptocurrency
Central bank digital currencies (CBDCs) and cryptocurrency represent fundamentally different approaches to digital money, although both exist in a digital format. The key distinction lies in their issuer and underlying nature. A CBDC is centralized, issued, and fully backed by a sovereign central bank, making it a liability of the state and a form of legal tender13. Its value is directly pegged to the national currency.
In contrast, most cryptocurrencies, such as Bitcoin, are decentralized, issued by private entities or algorithms, and are not backed by any government authority11, 12. Their value is typically determined by market forces, leading to significant price volatility. While some cryptocurrencies like stablecoins attempt to maintain a stable value by pegging to existing fiat currencies, they are still privately issued and do not carry the same government guarantee as a CBDC10. Furthermore, while some CBDCs may explore aspects of blockchain technology for their infrastructure, many retail CBDC implementations are not expected to rely on distributed ledgers, differentiating them from the core technological foundation of most cryptocurrencies.
FAQs
What is the primary purpose of a central bank digital currency?
The primary purpose of a central bank digital currency is to provide a digital form of sovereign currency, issued and backed by the central banks, to enhance the efficiency, safety, and inclusion of payment systems for the general public9.
Is a CBDC the same as the money in my bank account?
No, a CBDC is not the same as the digital money in your commercial bank account. Money in your bank account is a liability of the commercial banks, whereas a CBDC would be a direct liability of the central bank, similar to physical cash7, 8.
How would a CBDC benefit ordinary citizens?
A CBDC could benefit ordinary citizens by offering a universally accepted, secure, and potentially cheaper digital payment option, reducing reliance on private payment providers. It could also improve financial inclusion for those without traditional bank accounts by providing direct access to digital central bank money4, 5, 6.
Would a CBDC replace physical cash?
Generally, central banks envision a CBDC as complementing, rather than replacing, physical cash1, 2, 3. They aim to provide an additional choice for payments in an increasingly digital society, ensuring that central bank money remains accessible to the public.