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What is a Central Bank Digital Currency (CBDC)?

By Inyoung Hwang · February 17, 2021 · 4 minute read

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What is a Central Bank Digital Currency (CBDC)?

A central bank digital currency (CBDC) is virtual money issued as legal tender by the central bank of a country. While no major central bank has issued one yet, a CBDC would be similar to blockchain-based cryptocurrencies like Bitcoin that have increased in popularity but be backed by a sovereign nation like fiat money. CBDC would be like a government-issued virtual store of value.

A January 2021 survey by the Bank of International Settlements, a central bank group, found that 86% of central banks were exploring the pros and cons of digital currencies. The survey also found that about 20% of the world’s population could see their country issue a CBDC in the next three years, while developing economies were more likely than major ones to issue digital money.

The push comes amid greater threat that private virtual currencies like Bitcoin and Facebook’s Diem, formerly known as Libra, will see wider adoption. In addition, the Covid-19 pandemic further expedited a shift away from physical cash and coins that was already taking place with the advent of payment tools like PayPal and Venmo.

How CBDC would exactly work remains unclear, but they could potentially make digital payments easier, facilitate the implementation of central-bank monetary policy, or minimize the role of commercial banks in the financial system. A CBDC system could also pose unique advantages or challenges for each country issuing a digital currency.

How CBDC Could Work

Similar to physical cash, CBDC could be stored or used for payment. They will also likely carry a unique serial number, similar to how paper notes and coins in a fiat-currency system do. Many CBDC won’t be designed to replace cash anytime soon, but instead to complement physical money.

Currently, central banks do already issue a form of digital money but only to banks, which then lend that money to consumers and businesses. When people currently make payments or move money between multiple bank accounts, it usually goes through a patchwork of systems, often incurringl fees for the parties involved and taking a couple days for transfers to be completed.

CBDC could potentially cut out the middlemen, lowering or eliminating fees and making transfers faster. For instance, a Bitcoin transaction typically takes less than 10 minutes. Consumers could hold accounts directly with the central bank. CBDC could not only make digital payments easier but democratise central-bank money in a way.

That means CBDC could be a tool for monetary policy, giving central banks more control over currency supply and allowing them to better track the movement of money within the economy. Central banks could possibly also bypass financial markets and change interest rates directly on consumer accounts.

What Are the Risks of CBDC?

Of course, CBDC would be a disappointment to those who buy cryptocurrencies with the hope that a private decentralized form of digital cash, like Bitcoin, Ethereum or Litecoin, will one day displace traditional fiat money. Some argue that CBDC would mean a greater expansion of government, and that the anonymity that especially the most private cryptocurrencies offer will continue to fuel their appeal.

The emergence of CBDC could also be a destabilizing force on the existing financial system. If consumers can hold direct accounts with a central bank, commercial banks could get drained of retail deposits. One solution to this problem has been to potentially put a cap on how much can be held in CBDC, or not have central banks pay interest on retail deposits.

Another potential repercussion could be the start of a new kind of currency war. The U.S. dollar has been the world’s reserve currency since the 1920s. The rise of multiple sovereign digital currencies could challenge the current dollar-dominant system, making it less important for international trade and foreign-exchange transactions to be pegged to the dollar.

Examples of CBDC


China has been reported to be the major economy farthest along when it comes to developing a CBDC. The country’s central bank concluded a pilot program in late 2020 that involved distributing 200 digital yuan (roughly equal to $29.75) in “red envelopes” to 50,000 randomly selected consumers.

China’s program is designed to replace cash in circulation, not money held in long-term bank accounts. Commercial banks will have a role in distributing the digital money, according to reports. It also won’t use blockchain technology for the central database. Instead, both commercial bank distributors and the central bank will keep databases tracking the flows of digital yuan from user to user.


Sweden is another country trying to be at the forefront of moving toward digital currency. Unlike in China however, blockchain will underpin the electronic krona.

The BIS estimated in 2018 that the country is the world’s most cashless society. Riksbank, Sweden’s central bank, has said that the Covid-19 pandemic has accelerated a move away from coins and paper cash: less than 10% of payments are made with the country’s bank notes.


E-dollar? Fedcoin? The U.S. Federal Reserve has said it’s looking into different options involving digital currencies. Officials have said that Facebook’s Libra made the project more urgent.

However, Fed Chair Jerome Powell has said, “We do think it’s more important to get it right than to be first and getting it right means that we not only look at the potential benefits of a CBDC, but also the potential risks.”

Key issues that the Fed needs to understand include protection from cyber attacks, counterfeiting and fraud; how CBDC would affect monetary policy and financial stability; and how it could prevent illicit activity.


Venezuelan government launched its own digital currency in 2018 amidst a bout of hyperinflation that made everyday goods such as toilet paper and medicine unaffordable to many citizens. President Nicolas Maduro said at the time that each “Petro” token would be backed by a barrel of Venezuelan crude, the country’s chief export.

One year later however, critics claimed there was little evidence anyone was using the Petro however. Instead, news reports from 2019 discussed how Venezuelans were instead converting their bolivars into cryptocurrencies like Bitcoin in order to fend off the loss of value from hyperinflation.

The Takeaway

The Bahamas became the first country to issue a CBDC in October–the Sand Dollar. While no major central bank has issued a CBDC yet, the vast majority are researching and exploring them as the use of physical money drops off and projects like Facebook’s Diem gains momentum.

Proponents of CBDC argue that blockchain-based fiat currency could solve inefficiencies in the existing central banking infrastructure. Those more cautious warn that CBDC could also be vulnerable to hacks or outages. Meanwhile, enthusiasts of decentralized finance, or DeFi, argue for a financial system that moves away from centralized authority, rather than one that expands its influence.

It’s yet to be seen whether CBDC will usher in a new era of stable digital currency usage. So far, cryptocurrencies like Bitcoin and Ethereum have been popular for trading in markets, rather than as a mode of payment.

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