A beginner's guide to central bank digital currencies

To fulfill the evolving economic needs throughout history for the storage and transfer of value, several types of money have emerged. In their respective eras, coins, banknotes, checks, and credit cards were all innovations. New payment technologies have been added recently that utilize blockchain or digital ledger, such as stablecoins and Central Bank Digital Currencies (CBDCs). These technologies also range from phone-based mobile money to smartphone-based payment apps to blockchain-powered tokens.


This article will discuss what CBDCs are, its categories, pros and cons and some countries that are developing it.


What are CBDCs?

The existing types of central bank money, such as currency (bills and coins) and central bank settlement accounts, can be considered analogous to CBDCs in a digital sense. Several central banks have launched internal initiatives over the past few years to comprehend cryptocurrency technology better and, more broadly, the possible application of distributed ledger technology (DLT) to government-issued digital currencies. For example, central banks in countries like Canada, the Netherlands, Singapore, and the United Kingdom began conducting internal tests in 2015. These countries primarily concluded that DLT wasn't yet developed enough to be used in significant central bank payment systems.


The two categories of Central Bank Digital Currencies are wholesale and retail. Financial firms that have reserve deposits with a central bank can use a wholesale CBDC. It could be used to lower counterparty credit and liquidity concerns and increase the effectiveness of payments and securities settlement. The wholesale use of CBDC is seen by the Bank of International Settlements (BIS) as a way to improve the payments and settlement systems. On the contrary, a CBDC that will be sold to the general public is known as a retail CBDC. The advantages of retail CBDC based on DLT include traceability, anonymity, availability around the clock and throughout the year, and the viability of an interest rate application. Retail CBDCs also advance financial inclusion by hastening the transition to a cashless society and cutting costs associated with printing and handling cash.


The two primary models for delivering CBDCs are value and account-based. The public will access direct accounts with the issuing central bank through an account-based CBDC. One that is value-based involves creating digital money or tokenized cash for which the prepaid amount can be kept on hand, as on a card or electronic device.


Which countries are developing CBDCs?

Several central banks began researching digital currencies in 2016 for commercial interests and using DLT to settle high-value interbank payments. For instance, the Monetary Authority of Singapore introduced Project Ubin in November 2016 as a tokenized version of the Singapore dollar on distributed ledger technology. Sweden's Riksbank carried out the first publicly acknowledged research on retail CBDCs in 2017. Currently, the People's Bank of China's electronic Chinese yuan (e-CNY) is another CBDC initiative that has been testing the implementation of e-CNY in numerous Chinese cities since 2020. Additionally, the Central Bank of the Bahamas released the Sand Dollar, widely regarded as the first live retail CBDC, in October 2020, giving people access to a digital wallet through a mobile phone application or an actual credit or debit card.


Moreover, a Central Bank Digital Currency Taskforce was established by the Bank of England and HM Treasury (HMT) to monitor the use of CBDCs. Additionally, the European Central bank (ECB) integrated the advantages of central bank money with how individuals use and transact with money today by proposing the implementation of a digital euro. The Federal Reserve has been investigating the potential advantages and risks of central bank digital currencies from several perspectives, including technological research and experimentation, even though it has not decided whether to pursue or implement CBDCs.


The pros and cons of a CBDC

The pros of CBDCs

Central bank digital currencies (CBDCs) provide the distinctive benefits of central bank money in digital form, including liquidity, settlement finality, and integrity. They are a more sophisticated version of money for the digital economy that have a great potential to contribute significantly to modernizing current centralized payments and settlement systems. By relying on digital identification, CBDCs could reduce the risks associated with currency conversion and enhance cross-border payments. However, the barriers to sharing digital IDs across borders may be overcome through multi-CBDC arrangements, but this will require cooperation on a global scale.


Additionally, CBDCs must overcome fundamental disparities to interact with one another and traditional fiat currencies for their promise to be fully realized across borders. Using the well-known Quorum and Corda technologies, SWIFT and Capgemini could complete CBDC-to-CBDC transactions between several DLT networks and fiat-to-CBDC flows between these networks, a real-time gross settlement system. The achievement demonstrated that SWIFT's new transaction management capabilities could coordinate all inter-network communication and that blockchain networks could be connected for cross-border payments through a single gateway.


Furthermore,it is crucial to note that CBDCs may introduce disintermediation, the procedure of eliminating the intermediary who typically acts as a broker who connects buyers and sellers. It is possible due to blockchain technology that allows people to move money without requiring the banking system to authorize transactions.


The cons of CBDCs

Old and a few people among the young generation have limited knowledge of digital technology and may have trouble comprehending what digital currencies are, particularly in rural areas. This will restrict how effectively countries can employ a CBDC to further their well-being. Therefore, the nation must implement a comprehensive digital literacy program to solve this problem. Alternatively, such nations may allow co-existence of fiat and CBDCs for some time to accelerate adoption of government-controlled digital currencies.


A lack of privacy is another major drawback of CBDCs. Previously there were some measures to protect privacy, as local banks had transaction data on each person, and governments could only get this information via warrants or investigations. However, CBDCs would allow mass surveillance of every individual. Therefore, Central Banks must ensure that the CBDC platforms safeguard all users' mobile data, the bank application used to manage their CBDC holdings, and the connection between the mobile application and the backend server. In addition, the Central Bank will need to implement a multilayer defense system on the blockchain and CBDC platform to prevent data intrusions. The CBDC should include built-in defenses against harmful keyloggers, mobile malware, remote screen capture, and thoughtless screen sharing that organized crime networks can utilize to acquire CBDCs.


Suppose a government doesn't like a particular country or doesn't want its citizens to buy goods from a specific business. In that case, it could block all transactions utilizing the sanctions/ economic control pushed via CDBC. Citizens of a country or anyone who uses the CBDC would have little to no power to stop anything. Governments could end up stopping people from buying specific amounts of alcohol or spending money on certain foods, or subscriptions to controversial podcasts or websites.


Similarly, with CBDCs, governments could squash all political resistance by withdrawing or freezing the funds of any political opposition. This happened in Canada when peaceful truck drivers protesting vaccine mandates had their bank accounts frozen by the Canadian government. Later the drivers switched to using crypto to get donations to continue their protests, and Canada sanctioned over 34 crypto wallets. 


To prevent users from becoming targets of criminal groups, the Central Bank must encourage users to embrace more cutting-edge mobile security solutions. Furthermore, future person-to-person (P2P) transactions that do not need a financial intermediary will be facilitated by digital currency. As a result, financial institutions may become less important in a fully developed CBDC economy, resulting in a loss of significant income. For instance, to ensure that a CBDC economy does not negatively impact Nigeria's licensed banks and other financial institutions, the Central Bank of that country may need to assess the operationalization of the eNaira in that country.



The two main drivers are the threat that cryptocurrencies pose to national currencies and the uncertainty surrounding future global currency stability as the US dollar loses its exclusive status as the standard against which other currencies are measured and against which international trade is conducted. Typically, public justifications are more circumspect. A lot of tax evasion and fraud may be prevented by centralized control over the movement of money.


Moreover, money that can move without going through banks and clearing institutions is cheaper, especially for businesses that process thousands of daily transactions. While there are some benefits to CBDCs, such as faster settlement time and lower transaction costs for remittances and cross-border payments, there are significant downsides. A loss of financial privacy, lack of control over one's financial resources, and political repression remain huge risks that could harm freedom for individuals worldwide when a central bank controls CBDCs. While the benefits or costs for CBDCs can be observed, it must be noted that CBDCs are not cryptocurrencies. Self-custody of funds, partial privacy, and control over payments/withdrawals of assets are hallmarks of cryptocurrencies like Cardano but are completely non-existent with CBDCs.