Central bank digital currency

• 1. Introduction

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  A central bank digital currency does not sound like money that could expire. Yet in a trial of China's digital yuan in Shenzhen, some of it was programmed to do exactly that. The digital cash came with a built-in deadline, nudging people to spend it rather than save it. By the end of the trial, 90 percent of the vouchers had been spent in shops.

  Bitcoin and other cryptocurrencies are issued by private networks, not by governments. A central bank digital currency, or CBDC, is issued by a state instead, and it can work alongside physical cash. The promise is speed and reach: faster, cheaper payments that improve financial inclusion. But there is a flip side. Regulators worry about privacy, and about the currency becoming what one description calls a "tool for coercion and control." Rolling one out could also affect banks' financial stability, which is why careful policy design matters.

  Central banks were quietly testing digital cash long before anyone agreed on what to call it, and that groundwork came first.

• 2. Origins Before The Acronym

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  Finland's central bank issued the Avant stored value e-money card back in the 1990s, decades before regulators settled on the term CBDC. That term itself did not become widely used until after 2019, even though central banks had already spent decades experimenting with digital cash projects.

  In 2014, the People's Bank of China began researching the idea of issuing a CBDC. Ecuador's central bank ran its own mobile payment system from 2014 to 2018, a separate experiment happening around the same time.

  By 2021, Australia's central bank had gone further, running a proof of concept for a wholesale CBDC built on Ethereum. The pilot tokenized syndicated loans, aiming to automate and secure high-value transactions inside the banking sector.

  That Ethereum pilot pointed straight at a design question every central bank still has to answer: what should the underlying database actually look like?

• 3. Two Kinds Of Digital Money

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  Any CBDC would likely run on a database that keeps a running record of how much money every person or business holds, with privacy and cryptographic safeguards built in. It could share some features with cryptocurrency, including programmability, but a CBDC would stay centrally controlled even if it sat on a distributed database. That is why a blockchain or other distributed ledger would likely not be required. Blockchain technology was still the original inspiration for the whole concept.

  Retail CBDCs are designed for households and businesses making everyday payments, while wholesale CBDCs serve financial institutions and function much like central bank reserves. Retail CBDC, in this framing, is simply the digitization of sovereign currency, covering banknotes and coins. It also covers the wholesale CBDC reserves already used in the reverse repo and repo market.

  In the intermediated model, the central bank issues the currency and manages the core infrastructure, while financial intermediaries handle customer service. The European Central Bank and the Federal Reserve have both proposed intermediated CBDCs. A central bank could instead provide the full service itself, or delegate responsibilities even further.

  Whichever model a country picks on paper, the real test is whether it actually launches one, and by 2024 dozens already had.

• 4. The Global Scoreboard

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  Nine countries, plus the eight islands that make up the Eastern Caribbean Currency Union, have already launched a CBDC. Another 38 countries and Hong Kong are running CBDC pilot programmes, while 67 countries and two currency unions are still researching the idea.

  By March 2024, central banks in 134 countries, together accounting for 98 percent of the world's GDP, were evaluating some form of national digital currency. That group included the European Central Bank, the UK, and the US. China's digital RMB was already the first digital currency issued by a major economy.

  Six central banks are named as having launched a CBDC. They are the Bahamas' Sand Dollar, the Eastern Caribbean Central Bank's DCash, Nigeria's e-Naira, and Jamaica's JamDex. The list also includes China's digital renminbi, India's Digital Rupee, and Russia's Digital Ruble.

  Brazil's central bank has been testing its own digital currency, called Drex, since March 2023. The European Central Bank and the eurozone decided in October 2023 to move into a preparation phase for a possible digital euro. That followed a two-year study phase.

  Launching a currency is one thing; getting elected officials to agree on it is another, and that fight has already split several governments.

• 5. Political Fault Lines

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  In the United States, the Republican Party is generally opposed to central bank digital currencies. Sweden's Riksdag has been similarly unsympathetic to the Riksbank's enthusiasm for launching one, and Poland's National Bank is opposed outright. Ukraine, for its part, flagged the risk of disintermediating commercial banks as early as 2020.

  Some states have taken a different path, issuing cryptocurrencies instead of a central bank digital currency, such as Venezuela's Petro and the Marshall Islands' Sovereign. The intent behind those coins is often to increase a state's independence from global financial systems. That can mean cutting reliance on a foreign currency, or evading international sanctions.

  In February 2023, the UK Treasury and the Bank of England said a state-backed digital pound was likely to launch sometime after 2025. Two weeks later, a Swiss lobby group triggered a national vote on keeping a "sufficient quantity" of cash in circulation. The fear was that electronic payments make it easier for the state to monitor its citizens' actions.

  Commenting on the British government's plans, the BBC's Faisal Islam said the real issue was who gets access to the data attached to every spending transaction. He asked whether people might end up trusting a global company more than the state. "The eye here is on maintaining UK monetary sovereignty against upheaval from the likes of Big Tech," he said.

  Underneath these disputes sits a technical fork in the road: should a CBDC be easily traceable, and should it run on tokens or on accounts. More traceability means more government control, and the answer also decides how much anonymity users are allowed to keep.

  Those unresolved design choices, traceable or anonymous, tokens or accounts, determine what the money itself actually becomes.

• 6. What Actually Makes It Money

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  Unless it pays a dividend, a central bank digital currency is simply a digital counterpart to fiat money, issued directly by the central bank. If it does pay a dividend, the source treats it differently, as an ownership stake in the central bank and a new form of legal tender.

  Like a paper banknote, a CBDC serves as a means of payment, a unit of account, and a store of value. And like paper currency, every unit stays uniquely identifiable, a feature meant to prevent counterfeiting.

  Digital fiat currency sits inside the base money supply alongside every other form of the currency. That makes it a liability of the central bank, just as physical currency is. It works as a digital bearer instrument, something that can be stored, transferred, and transmitted through any digital payment system or service. Its validity does not depend on whichever payment system happens to be storing or moving it at the time.

  Many CBDC proposals go further still, calling for universal bank accounts to be offered directly at the central bank for every citizen.

  A universal account at the central bank sounds simple enough on paper, but it is exactly the kind of promise that supporters and critics read in opposite directions.

• 7. The Promised Upside

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  Real-time transfers directly from payer to payee could replace today's reliance on banks and clearing houses as go-betweens. When payment verification is instant, merchants no longer need to absorb the risk of a payment failing to arrive. That same speed removes the waiting queue created when a customer claims to have paid but the money has not shown up yet. Cutting or eliminating the fees charged by systems like Visa, Mastercard, and American Express could also push prices down. That, in turn, could pull more people into using digital payments.

  A safe account at the central bank, offered free or at low cost, could extend a basic bank account to any legal resident or citizen. That is the financial inclusion case at the heart of most CBDC proposals.

  Because a CBDC can track the exact location of every unit in circulation, at least in a centralized database, it could help prevent illicit activity. That same visibility makes tax avoidance and evasion far harder, since offshore banking and unreported employment become difficult to hide from the central bank or government. Cryptocurrencies, by contrast, are described as a risk to that same crackdown on corporate tax avoidance.

  The same tracking makes criminal activity easier to spot and money laundering much harder to pull off. It could also make it straightforward to reverse a transaction and return stolen money directly to a crime victim.

  A digital record of every transaction would also serve as proof that money changed hands. That avoids cash problems like short-changing, theft, and conflicting accounts of what was paid.

  Supporters also frame a CBDC as protecting money as a public utility. It would offer a modern alternative to physical cash at a time when cash's abolition is already being discussed. A secure, standard, and interoperable CBDC, governed by a central bank, could boost confidence in the wider payment system and sharpen competition among providers. It could also preserve seigniorage income, the revenue governments would otherwise lose if physical cash disappeared.

  Free accounts offering complete safety of deposits could push banks to compete harder for customers, for instance by reviving interest-bearing sight deposits.

  Transfers of central bank money straight to the public could also open a new channel for monetary policy, sometimes called helicopter money. That would give policymakers more direct control over the money supply than indirect tools like quantitative easing and interest rates. It could even point toward a full reserve banking system. One proposal even suggested a demurrage currency, shaving off small fractions of a unit's value on a set schedule as a supplement to ordinary inflation targets.

  For anyone wary of a bank run, a CBDC could offer an alternative to fractional reserve banking altogether, despite the relative safety deposit insurance already provides.

  Every one of those advantages assumes the design gets built carefully, and not everyone is convinced it can be.

• 8. Who Holds The Switch

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  If depositors decide a CBDC beats a bank account on safety, liquidity, solvency, and general appeal, they could shift their money out of the banking system. In the extreme, that shift could trigger a bank run and leave banks' funding positions weaker. The Bank of England, however, found that following a set of core principles when introducing a CBDC addresses the risk of a system-wide run. A central bank could also cap demand directly, for instance by setting a ceiling on how much of the currency anyone can hold.

  Most CBDCs are centralized, unlike most cryptocurrencies, which are decentralized. That means whoever controls issuance can add or remove money from an account with, as the source puts it, "a flip of a switch."

  A well-run foreign digital currency could also replace a country's own money, the same dynamic long seen in ordinary dollarization. Facebook's announcement of its Libra project helped draw central bankers' attention to CBDCs in the first place. China's progress with its DCEP system, relative to other Asian economies, added to that attention.

  Privacy critics describe a CBDC as giving governments "direct visibility of financial transactions," calling it an "eagle-eyed view on the spending of everyone." Others go further, warning that a digital currency hands a country "broad new powers when it comes to surveillance and controlling its population." Without adequate privacy protections, tracing money routes could erode financial privacy, encourage self-censorship, and even stall broader social developments.

  Cybersecurity is a risk to any payment infrastructure, and a CBDC would represent critical infrastructure in its own right. That makes it a potentially high-value target for cyberattacks, even as it offers resiliency as a new payment method.

  Some critics frame the risk in blunter terms, warning that digital currency "will simply become an extension of the surveillance state." One warning states it could see citizens "fined in a split second for behaviors deemed undesirable." It adds that dissidents and activists could see their wallets "emptied or taken offline." A related worry is that digital currencies "could also empower the state to make it impossible to donate to a vocal NGO." Some warn a government could use the same tool to prohibit someone from being able to "purchase alcohol on a weekday." Being programmable also means a government could theoretically issue money that expires after a set time. Or it could issue money that only works for certain purchases, shaping spending behavior directly.

  American policy analyst Avik Roy argues that a CBDC inherently expands government control and conflicts with American privacy norms. He points to regulated stablecoins as an alternative capable of offering similar digital benefits with stronger privacy protections. On that basis, Roy opposes the United States adopting a central bank digital currency at all.

  Roy's own alternative, regulated stablecoins, is now folded into the very debate over digital money that central banks worldwide are still trying to settle.