Over the past decade, physical currency has been gradually disappearing and electronic money has been on the rise.

Cashless transactions are becoming more common in the private sector, and digital currencies comprise a larger percentage of investment portfolios.

This trend is driving competition, with governments and central banks racing to introduce their own digital currencies.

This is Central Bank Digital Currencies, Unpacked.

CBDCs are often confused with cryptocurrencies. Both are digital assets, but this is where the similarity stops.

Cryptocurrencies are issued within decentralized networks, like blockchains, and are not tied to any one entity.

Transactions are recorded on a publicly distributed ledger. They are generally considered too volatile to become a widely accepted payment method.

There is concern that broad adoption of cryptocurrencies across economies could hurt domestic currencies and cause monetary policy to become less effective. This is why more institutions are exploring their own CBDC.

A CBDC is digital currency issued and controlled by a country’s central bank.

Like how credit cards or apps are used to make payments, CBDCs can be transferred across networks and bank accounts.

CBDCs are also risk-free, so they’re not subject to an institution’s liquidity or credit liability issues. This is different from money kept in a commercial bank.

This system could also improve cross-border payments. Typically, they involve several parties across jurisdictions and time zones.

Digital currencies accepted between countries could reduce transaction time and reduce overall costs.

Financial inclusion is another benefit of CBDCs With the rise of digital payments, many retailers in South Korea, China, and the U.K. no longer accept cash. Access to CBDC with e-wallets would help these consumers make digital payments.  

Across the globe, CBDCs are in different stages of development. In 2020, The Central Bank of The Bahamas issued the Sand Dollar, which is the digital form of the Bahamian Dollar.

And in 2021, the Central Bank of Nigeria launched the eNaira.

China’s CBDC is at the most advanced stage compared to larger economies. Their digital yuan is available to 10% of the country’s population across around 9 major cities in China.

The European Central Bank and the U.S. Federal Reserve are both considering launching digital currencies and there are many things to consider including:

Who holds the CBDC? Is it the general public? Non-financial institutions?

Who handles account openings and payment execution? Is that the responsibility of the central bank or a third-party?

Who handles conversions to cash or bank deposits? If consumers convert too quickly, it can impact a bank’s overall liquidity reserve.

Should CBDCs be interest bearing? This means that central bank policy rates would be directly passed to the economy. Currently, Central Banks seem to prefer making these deposits noninterest bearing because it reduces the risk of competition with other banks.

Imposing limits on digital currency balances is being explored as a way to help reduce this risk.

The main change CBDCs could offer, though, would be allowing non-financial institutions and the general public access to an electronic form of money that has the backing of the central bank.

There is a risk that soon retailers will no longer accept physical payments. Access to CBDC through a digital wallet will enable more people to make digital payments, adding convenience and efficiency to the consumer experience.