Central Bank Digital Currencies and Their Role in the Financial System

Central bank digital currencies are a digital representation of a country’s fiat currency. They are effectively a government-issued cryptocurrency designed to replace the traditional, physical form of fiat currencies.

The term CBDC is broad because its implementation involves several critical decisions on the part of an issuing central bank. The primary decision is whether a CBDC should be a general-purpose in that it’s available to be used by the general population. If not, then the issuing authority may decide to make it available for “wholesale” transactions, which means the CBDC is only used for settlements between banks. Finally, a CBDC could also only be used among central banks.

In its research paper covering CBDCs in-depth, the Bank for International Settlements, or BIS, defines these categories using a Venn diagram called the “money flower,” shown below. The gray area represents various types of CBDCs, while Bitcoin (BTC) and other cryptocurrencies are deemed to be private digital tokens.

The money flower: A taxonomy of money

What’s the background of CBDCs?

According to the BIS, the idea of CBDCs has been around for many years, predating Bitcoin by over two decades. However, the concept has gained prominence over recent years. This has been mainly due to advances in the fintech arena, including developments in blockchain technology, allowing the issuance of digital tokens that represent a store of value. 

Furthermore, the move toward CBDCs supports the general trend of a more cashless society. In countries such as South Korea, China and Sweden, cash is well on its way to becoming a redundant means of payment.

What are the benefits of CBDCs?

CBDCs offer many comparable benefits to cryptocurrencies, such as Bitcoin. Hours of operation for banks limit the availability of transactions, whereas CBDCs could be available to transact on a 24/7 basis. Banks could decrease their reliance on clearinghouses, which would save costs.

Like cryptocurrencies, CBDCs could be available to anyone who has a smartphone, helping to improve financial inclusion, particularly to people in rural areas without access to physical banking infrastructure such as ATMs. Countries such as Kenya have already seen an improvement in financial inclusion due to the popularity of M-Pesa, a cashless payment app based on SMS.

There are other benefits in using CBDCs beyond the general advantages of digital currencies. Central banks spend money to print money, with the average cost of minting a one-dollar bill racking up around $0.077 per note. Digital currencies are cheap or sometimes even free to produce once the underlying code is there.

Central banks could also implement monetary policy directly using a CBDC. This may mean paying interest on the token itself rather than on bank deposits. 

Finally, governments could find it easier to distribute cash to citizens, using CBDCs. For example, COVID-19 led to a crisis that prompted the United States government to issue Economic Impact Payments in the form of checks and debit cards, which are prone to theft and fraudulent use. With a CBDC, the government could issue relief funds directly.

What are the risks of CBDCs?

Along with various benefits, CBDCs also come with some considerable risks on the part of central banks, governments and individual citizens.

Perhaps the biggest risk is cybersecurity. China’s efforts in testing a CBDC have already been hijacked by scammers, which is alarming because the full version hasn’t been officially launched yet. The risks of a network attack or creating new loopholes for fraud or money laundering are a real concern for any central bank looking to launch a CBDC. 

On the flip side of this risk is privacy. The greater visibility a government has into who is using a CBDC, the more the cybersecurity risks can be reduced. However, if citizens believe that using a CBDC may mean the government could overstep the boundaries of privacy rights, it may not gain adoption.

Finally, while governments could use a CBDC to implement monetary policy, the new possibilities that this opens could also create some degree of risk. For example, using a CBDC to charge negative interest rates in a time of crisis could fundamentally change economic paradigms, making it too costly for citizens to store their wealth in the new digital cash.

Which central banks are close to issuing their own digital currencies?

Although many central banks use some form of digital money as reserves or settlement account balance, no central bank has yet issued any general CBDC. However, several banks are already in various stages of research and development, including the five major currencies of the world — the U.S. dollar, the euro, the Japanese yen, the British pound and the Chinese yuan.

In May, a U.S. thinktank published a white paper outlining the aims of the “digital dollar.” Since then, events have been making significant headway. 

The most recent news from Japan is that the central bank has appointed its leading economist to head up a team researching a yen-based CBDC, while the Bank of England has appointed Accenture for its own CBDC development. Meanwhile, the European Central Bank appears to be leaning toward a retail CBDC, and given the fact it would operate across 19 countries, this makes it the biggest project at the moment. 

However, China has been undoubtedly leading the pack, having hit several headlines for months with plans for its CBDC launch. The latest is that the government is planning to target the financial dominance of domestic payment firms, Alibaba and Tencent.

The Philippines has also confirmed that it has been looking into issuing its own digital currency, while Thailand is already in the test phase.

How the U.S. government is applying a new view of crypto, and how new bills are laying the groundwork

In late July, the U.S. Office of the Comptroller of the Currency issued a memo giving the green light to all federally charted banks to offer cryptocurrency custodial services. This effectively allows hundreds of OCC-member banks to integrate crypto services. The Federal Deposit Insurance Corporation insurance for crypto holdings is also now within the realms of possibility.

Banks now only need to implement the necessary software, hardware and security policies to be ready to start processing cryptocurrencies, which could also include a CBDC.

A week after the memo, Brian Brooks, the acting comptroller of the currency, vocalized his support for a blockchain-based CBDC as an upgrade to the current U.S. banking system. Most recently, Federal Reserve Governor Lael Brainard confirmed that the Boston Federal Reserve Bank will work with the Massachusetts Institute of Technology on CBDC research.

The COVID-19 relief effort is acting as a catalyst for the introduction of “digital dollars” as referenced in the Automatic Boost to Communities Act introduced by the U.S. Congress. This came after the introduction of a bill in March dubbed the Cryptocurrency Act 2020, which attempts to clarify the responsibility for regulating digital assets by federal agencies.

The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.

Marshall Hayner is the CEO and co-founder of Metal (MetalPay, Proton and MetalX). Marshall is an expert in the regulatory aspects of cryptocurrencies and was recently among the founding members of a cryptocurrency bill that was presented to Congress. In addition, Marshall started the first Facebook-integrated Bitcoin wallet called QuickCoin in 2014, but he has worked on numerous digital currency projects including Dogecoin, Stellar,, ChangeTip and the Bitcoin Fair.

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