Central Bank Digital Currencies (CBDCs): What You Need to Know

Central bank digital currencies have been touted as the future of money — the 21st century’s answer to physical banknotes and coins, which saw their popularity dwindle during the coronavirus pandemic.

But while CBDCs could see blockchain technology play a starring role in a modernized financial system, there’s no shortage of criticism. Concerns have been raised about potential privacy yearamifications, with conspiracies abounding that they could be used to control our spending.

Here, we’re going to explore these digital assets in greater depth — from the countries where they’re already in operation, to the potential use cases. We’ll also examine how CBDCs differ from decentralized cryptocurrencies like Bitcoin.

What is a CBDC?

Central banks play a starring role in determining a country’s monetary policy — setting interest rates, attempting to keep inflation under control, and putting currency into circulation. There’s just one problem: the number of people relying on cold, hard cash has fallen sharply in recent years. This has coincided with a massive jump in the number of transactions being made online. Figures from the U.S. Federal Reserve suggest that Americans under 55 used cash for just 12% of their payments in 2023.

We’re seeing similar trends play out around the world, and that’s a source of worry for central banks. Policymakers are uneasy that consumers and businesses are becoming increasingly reliant on infrastructure from private institutions. Stablecoins — digital assets pegged to the value of fiat currencies like the U.S. dollar — have also gained momentum. Central bank digital currencies have been touted as their response to this issue. This would see central banks release their currencies in electronic form — sitting alongside metal coins and paper banknotes. There are two main types of CBDC to be aware of.

Retail CBDCs

As the name suggests, retail CBDCs are designed to be used by everyday consumers and companies for day-to-day transactions. Funds would be held in a wallet, stored on a digital device.

While you could argue that this has the potential to disintermediate banks and even make them obsolete, many countries plan to ensure that financial institutions would play a key role in offering CBDC wallets to their customers.

Wholesale CBDCs

This type of CBDC is not intended for the general public. Instead, it’s meant to allow banks to settle large transactions between each other far more quickly and cheaply than at present. It could also help streamline cross-border payments.

Global tests involving multiple countries have taken place to put this infrastructure through its paces — with initial findings suggesting that they boost transparency and open the door to conditional payments, where funds are only released once certain parameters are met.

Who is Developing CBDCs?

The Atlantic Council, a U.S. think tank, has been tracking the development of central bank digital currencies for several years. It says more than 130 countries and currency unions—collectively representing 98% of the world’s gross domestic product—are now exploring whether to launch a CBDC.

Dozens are now engaged in pilot programs involving the public or are in the advanced stages of building the infrastructure that will power these digital assets. Extensive consultations involving consumers and businesses have also taken place.

Examples of CBDCs

Some countries have been engaged in an aggressive race to be among the first to offer a CBDC to the public — perhaps hopeful of establishing a first-mover advantage and increasing their fiat currency’s influence in the process. Others have struck a more cautious tone by adopting a “wait-and-see” approach to monitor how the rollout goes elsewhere.

The Bahamian Sand Dollar

History was made in The Caribbean back in October 2020 when The Bahamas became the first country worldwide to launch a fully functioning CBDC.

The Bahamian Sand Dollar is an electronic version of the Bahamian dollar, which is, in turn, pegged on a one-to-one basis with the U.S. dollar.

This CBDC only operates within the country and is accessible through dedicated apps on iPhone and Android devices — as well as physical payment cards.

Just some of the stated goals include modernizing the country’s payment systems, clamping down on money laundering, and tackling the threat of counterfeit coins and banknotes.

DCash

Elsewhere in the region, the Eastern Caribbean Central Bank unveiled DCash, which is in operation across eight islands.

A primary goal of this project is to boost financial inclusion for those who don’t have access to a bank account, as peer-to-peer transactions can be made using smartphones. Work is now underway to create DCash 2.0, which promises to deliver user experience improvements and the ability to make recurring and programmable payments.

JAM-DEX

With the slogan “no cash, no problem,” JAM-DEX is the official CBDC of Jamaica. As well as enabling payments to be made through QR codes, this digital asset ensures the financial system operates around the clock, every day of the year — as opposed to banks that only offer their services during business hours on weekdays.

Primarily because of the country’s size and position as an economic superpower, China’s digital yuan has received a lot of attention. Now available in dozens of cities and being rolled out further, Beijing made a splash by announcing it would be an accepted payment method during the Winter Olympics in 2022. Banking officials have said that this CBDC offers “controllable anonymity,” meaning transactions may only remain confidential to a point.

Digital rupee

India’s CBDC, the digital rupee, launched in December 2022 and aims to reduce the huge costs associated with printing physical cash. A wholesale version exists for financial institutions, while consumers and businesses can use a retail-facing alternative.

One year after launch, the Reserve Bank of India announced that the digital rupee was being used for one million transactions a day — but this is largely because banks were incentivizing their customers to adopt it.

eNaira

Nigeria’s central bank became the first in Africa to launch a CBDC in October 2021. Built on top of the Hyperledger Fabric blockchain network, transaction limits for the eNaira are determined by the know-your-customer checks a consumer has completed.

Someone who only has a phone number can hold a maximum of 120,000 naira (about $75) in their wallet. That rises to 300,000 naira ($185) if they have a National Identification Number, and 500,000 naira ($308) with a Bank Verification Number.

What about the US, UK, and the EU?

Other major economies have been pretty slow off the mark when it comes to launching a CBDC — and some are yet to decide whether to develop one. The Federal Reserve has previously said that it is “nowhere near recommending, let alone adopting, a central bank digital currency” in any form.

Instead, it’s been focused on holding consultations and experimenting with technology. Many lawmakers have also raised concerns about privacy. Although the UK’s Labour government has stated that it’s committed to creating a digital pound — known informally as “Britcoin” — the Bank of England is yet to formally begin designing one, meaning it could be several years away.

Meanwhile, the European Union is currently in the middle of what it calls a two-year “preparation phase” as it deliberates whether to push ahead with a digital euro. Particular attention is being paid to enabling offline payments, and how it would be integrated into smartphones. Officials there have warned that the plans could still end up being abandoned.

The Challenges of Creating a CBDC

At this point, you may be wondering: why is all of this taking so long? Well… in short, creating an electronic version of an official fiat currency from scratch isn’t easy.

Careful consideration is needed to ensure a CBDC works well in rural areas where there’s a lack of internet access. The infrastructure also needs to be compatible with existing systems, and safeguards are needed in the event of a cyberattack.

While some of these digital assets have been created on top of blockchains, there are concerns that these networks may lack the capacity to handle a large volume of daily transactions while keeping costs low.

It’s a steep learning curve for consumers who may be unfamiliar with digital wallets too, and they’ll want assurance that they’ll enjoy the same degree of privacy as cash.

There’s also a worry that CBDCs could actually end up contributing to economic instability — especially if they cut commercial banks out of the picture. Financial institutions play a vital role in lending to consumers, especially when it comes to mortgages. A shift to CBDCs could undermine this business model and exacerbate the risk of bank runs.

What Makes CBDCs Different From Cryptocurrencies?

Certain central bank digital currencies may use the same infrastructure as altcoins, but there are still significant differences between the two. They include:

• Centralization: As the name suggests, CBDCs are issued by centralized authorities who retain full control, meaning their supply can scale up or down when needed. Meanwhile, cryptocurrencies like Bitcoin are decentralized. This means no single person is in charge, with the number of BTC that will ever exist fixed at 21 million.
• Stability: A CBDC is always pegged on a one-to-one basis with the fiat currency it represents. Meanwhile, cryptocurrencies are famed for their volatility and can fluctuate wildly in price. While stablecoins are pretty similar to CBDCs, they aren’t official — and during past incidents of market turbulence, they’ve ended up being worth less than $1.
• Legal tender: More than 15 years after launch, Bitcoin isn’t widely accepted as a payment method — with El Salvador and the Central African Republic the only two countries where it has officially become legal tender. By default, CBDCs will be granted this status by default.
• Permissioned blockchains: CBDCs typically run on centralized networks with a small number of people who have been granted permission to participate, delivering cryptographic security without compromising on control. By contrast, anyone can join a permissionless blockchain like Bitcoin and Ethereum without restriction.

Pros and Cons for Consumers

CBDCs remain a pretty experimental type of digital asset — meaning that we’re yet to fully appreciate the potential use cases that could arise in the future. Nonetheless, some clear pros and cons have already started to emerge.

Advantages

• Faster transactions: Whereas some payments can take several business days to clear, CBDC transfers could be settled instantaneously.
• Cheaper international payments: CBDCs could be especially useful for remittances, where foreign workers send cash back home to their loved ones. This currently attracts an average global fee of 6.35% — eating into incomes — but a central bank digital currency could dramatically reduce this.
• Greater levels of automation: In time, CBDC infrastructure could allow tax to be collected automatically, reducing evasion and minimizing stress for consumers. Programmable payments would mean a CBDC can only be spent on specific purposes, such as food or childcare, with funds released if certain conditions are met.

Disadvantages

• Greater surveillance: If Alice hands Bob a $20 note in the street, no one would necessarily know that transaction took place. But if this same $20 was transferred from one CBDC to another, the payment may no longer be anonymous. Central banks have been seeking to reassure the public that privacy-preserving measures will be enforced.
• Restrictions: Many CBDCs impose limits on the total balance that a single consumer may have, while others also don’t offer interest on savings. This can deter adoption because funds would be gradually eroded by inflation over time.
• Cash under threat: There are concerns that CBDCs could eventually lead to physical coins and banknotes being phased out of the economy. Older consumers who lack the technical knowhow to operate a digital wallet would be hardest hit — but most central banks have insisted that both cash and CBDCs will operate alongside each other.

Criticism of CBDCs

The growing momentum of CBDCs has attracted plenty of criticism from Bitcoin maximalists and libertarian politicians, who fear they could be used to control spending.

Unfounded theories include suggestions that a CBDC could limit the number of flights that someone takes a year to tackle climate change, restrict how much red meat someone could purchase, or ban the purchase of alcohol after 1 a.m.

While there’s no evidence to suggest any of this is currently happening—or will happen in the future—such scenarios aim to illustrate how these digital assets could erode financial freedoms. Skeptics have also openly questioned why central bank digital currencies are needed in the first place, arguing that they offer few tangible advantages over current payment platforms.

This, coupled with the fact that many consumers aren’t even aware of CBDCs, suggests governments may face an uphill struggle when trying to launch one nationwide. The coming decade will be significant as more CBDCs come online. But the transition may not be smooth — and some countries may conclude that it simply isn’t worth the effort.