Central Bank Digital Currencies (CBDCs)
Government-Backed Digital Money
Introduction
As cryptocurrencies and stablecoins have grown, central banks have asked: should we create digital currencies ourselves? Central Bank Digital Currencies (CBDCs) represent government-backed digital money issued directly by central banks, combining official currency familiarity with digital capabilities.
Interest in CBDCs reflects multiple motivations: maintaining monetary sovereignty as private digital currencies grow, improving payment efficiency, reducing costs, and extending financial services to unbanked populations.
This lesson examines CBDCs: what they are, how they might work, and the debates surrounding their implementation.
What Is a CBDC?
A CBDC is a digital form of central bank money, similar in concept to physical cash.
The Distinction:
Just as physical cash is a direct liability of the central bank—you can always exchange it at face value—a CBDC would be a digital liability with the same characteristics.
This distinguishes CBDCs from:
- Bank Deposits: Liabilities of commercial banks, not central banks
- Stablecoins: Issued by private companies
- Cryptocurrencies: Decentralized, no issuer backing
Types of CBDCs:
Retail CBDCs:
- Available to the general public
- Used for everyday payments
- Could be held in digital wallets
- Most discussed type
Wholesale CBDCs:
- Limited to financial institutions
- For interbank settlements
- Improving existing systems
- Less controversial, narrower scope
Technical Approaches:
CBDCs can use different technologies:
- Distributed ledger technology (blockchain-based)
- Centralized databases
- Hybrid approaches
- The choice affects properties and capabilities
CBDC Programs Worldwide
China: Digital Yuan (e-CNY)
The most advanced major economy program:
- Piloted in numerous cities
- Millions of users in trials
- Two-tier structure: central bank issues to commercial banks, which distribute to users
- Programmable features possible
- Part of broader financial system modernization
The Bahamas: Sand Dollar
First nationwide CBDC (2020):
- Full rollout across islands
- Focus on financial inclusion
- Reaching communities without bank branches
Nigeria: eNaira
Africa's first CBDC:
- Launched October 2021
- Adoption has been slower than hoped
- Learning from implementation challenges
Caribbean Nations:
Multiple pilots and launches:
- Eastern Caribbean DCash
- Jamaica JAM-DEX
European Central Bank:
Developing a digital euro:
- Investigation phase ongoing
- Privacy a key design consideration
- Years from potential launch
- Would complement cash, not replace it
United States:
Taking a cautious approach:
- Federal Reserve studying options
- No commitment to launch
- Research papers published
- Debate about necessity and design
Design Considerations
CBDC design involves difficult trade-offs:
Privacy vs. Surveillance:
Cash is anonymous; digital systems can record everything.
The Spectrum:
- Complete anonymity (like cash): Enables illicit use
- Complete transparency: Unprecedented government visibility
- Middle ground: Anonymous small transactions, identification above thresholds
Privacy is the most contentious design question, with strong views on both sides.
Programmability:
Digital currency could be "programmable":
- Targeted stimulus payments
- Expiration dates
- Restricted uses (e.g., only food purchases)
Concerns:
- Government control over spending
- Slippery slope to financial control
- Potential for abuse
Interest-Bearing:
Should CBDCs pay interest?
- Positive rates could attract deposits
- Could compete with bank deposits
- Could enhance monetary policy transmission
Holding Limits:
Many designs include holding limits:
- Prevent large-scale migration from bank deposits
- Maintain commercial banking role
- Typically discussed at moderate levels
Motivations and Concerns
Why Central Banks Are Interested:
Financial Inclusion:
- Reach unbanked populations
- Lower barriers than bank accounts
- Works with smartphones (potentially feature phones)
Payment Efficiency:
- Faster, cheaper transactions
- Especially for cross-border payments
- Reduce reliance on legacy systems
Monetary Sovereignty:
- Response to private digital currencies growing
- Maintain central bank relevance
- Counter potential dollarization through stablecoins
Competition and Innovation:
- Provide public payment infrastructure
- Enable innovation built on CBDCs
- Alternative to private payment dominance
Concerns and Criticisms:
Privacy and Surveillance:
- Could enable unprecedented government visibility
- Every transaction potentially tracked
- Concern about authoritarian applications
- Even democratic governments could abuse
Bank Disintermediation:
- If people prefer CBDCs to bank deposits, banks lose funding
- Could destabilize banking system
- Banks might need new business models
Cybersecurity:
- Attractive target for hackers
- Single point of failure
- Operational risks
Complexity:
- Technical challenges significant
- Integration with existing systems difficult
- Risk of problems at scale
Relationship with Existing Money
CBDCs would exist alongside, not replace, existing money forms:
Coexistence:
- Cash likely continues (at least for now)
- Bank deposits remain dominant for most
- Multiple payment options
Competitive Dynamics:
- If CBDCs offer advantages, might see migration
- Banks may need to compete harder
- Payment providers affected
Stablecoins and Crypto:
Interesting competitive landscape:
- CBDCs as government response to private stablecoins
- Some argue CBDCs make stablecoins obsolete
- Others see coexistence
- Crypto maximalists reject the concept entirely
International Implications:
Cross-border considerations:
- Could improve international payments
- Currency competition questions
- Coordination challenges
- Potential for "digital currency areas"
Implementation Timeline
Current State:
Most major economy CBDCs remain years from widespread deployment:
- Research and investigation phases
- Pilots in limited areas
- Political decisions required
- Careful rollout essential
Smaller Economies:
May move faster:
- Less complex financial systems
- Clearer problems to solve
- Providing lessons for larger economies
Uncertainty:
Much remains unknown:
- Technology continues evolving
- Political priorities may shift
- Design choices not finalized
- Public acceptance uncertain
Watching Developments:
Key things to watch:
- China's digital yuan expansion
- ECB digital euro decisions
- US Congressional and Fed discussions
- Emerging market launches
Key Takeaways
- CBDCs are digital forms of central bank money, carrying government backing unlike private digital currencies
- China's digital yuan is the most advanced major economy program, while smaller countries have launched CBDCs
- Key design debates center on privacy, programmability, and impact on commercial banking
- Motivations include financial inclusion, payment efficiency, and maintaining monetary sovereignty
- Most major economy CBDCs remain years from deployment
Summary
CBDCs represent government-backed digital money under exploration by central banks worldwide. While China has advanced significantly and smaller economies have launched CBDCs, major Western economies are proceeding cautiously. Design choices around privacy, programmability, and banking impact carry significant implications. CBDCs will likely coexist with existing money forms, adding another option in the evolving digital finance landscape.