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Central Bank Digital Currency (CBDC)

Updated: Oct. 06, 2022Written By: Richard LehmanReviewed By:

A Central Bank Digital Currency is a version of an existing fiat currency in digital form. More than 90 countries, including the U.S., are either looking into creating a CBDC or have already implemented one. Learn what a CBDC is and why so many countries are considering them.

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What Is CBDC?

A Central Bank Digital Currency (CBDC) is a digital version of an existing fiat currency. Its price is pegged to that currency. A CBDC would, like its fiat counterpart, be backed by the "full faith and credit" of its issuing government.

In January 2020, the U.S. Federal Reserve Board of Governors posted a message on the Internet saying they are looking into the idea of a CBDC to "improve the safe and efficient domestic payments system". The Fed explained that electronic payments of US dollars are widely used already, but those payments are liabilities of the financial institutions (namely commercial banks) where individuals and businesses keep their dollars. In contrast, a CBDC would represent a liability of the central bank itself, just like the physical dollar.

Note: The complete Fed document is titled "Money and Payments: The US Dollar in the age of Digital Transformation" and is freely available on the Internet.

CBDC vs. Cryptocurrency

While CBDCs exist in digital form, they are distinctly different from digital cryptocurrencies. Some of the specific differences include the following:

  • Government backing: CBDCs are sanctioned, supported, and backed by the good faith and credit of a central government. Cryptos are not.
  • Creation: CBDCs cannot be privately created (or 'mined') by individuals. Cryptos such as bitcoin can be mined by anyone.
  • Anonymity: CBDCs cannot be anonymous like a cryptocurrency.
  • Holding location: CBDCs can be held in a publicly sanctioned repository rather than a personal 'wallet'.
  • Pricing: CBDC prices are pegged to an underlying fiat currency. , Crypto prices are not, with the exception of stablecoins.

Purpose of Central Bank Digital Currency

CBDCs are intended to serve the same general purposes as fiat currency with added advantages that can be derived from their digital structure. More specifically, CBDCs offer:

  • Enhanced currency transferability
  • Accessibility for those without a bank account
  • Potentially cheaper and faster transactions
  • Greater efficiency with cross-border exchanges
  • Better security and lower volatility than cryptocurrencies

It is also no secret that many governments are concerned about the proliferation of independent cryptocurrencies like bitcoin and would rather have their own versions of a digital currency than one that operates outside their control. In addition, they would want to be able to use a CBDC to help implement monetary policy as well as to get their share of taxes owed, and be able to trace the movements of currencies for law enforcement and national security purposes.

Types of CBDCs: Wholesale vs. Retail

CBDCs can have separate versions for financial institutions (wholesale) and businesses and consumers (retail).

1. Wholesale CBDCs

Wholesale CBDCs equate to the physical reserves that a regular bank deposits with the central bank. In the U.S., banks maintain accounts at the Fed for reserve deposits and interbank transfers. Deposits at the central bank are subject to monetary policy actions by the central bank such as minimum reserve requirements and paying interest on reserve balances.

2. Retail CBDCs

Retail CBDCs are designed for consumers and businesses and can be transacted directly between them, thereby reducing or eliminating the risks (and fees) associated with intermediaries.

Retail CBDCs can be 'token-based', which are accessible with private/public keys (and thus anonymous), or 'account-based', which require digital identification.

Countries Adopting CBDCs

CBDCs are already being implemented in several countries and a great many more are said to be considering doing so. According to NDTV, a report from AtlanticCouncil.org lists 87 countries that are considering issuing a CDBC and 9 countries that have already launched one. These include:

  • The Bahamas
  • Nigeria
  • Eastern Caribbean Currency Union (ECCU): Antigua and Barbuda, Dominica, Grenada, Montserrat, St. Kitts and Nevis, Saint Lucia, and St. Vincent and the Grenadines

The Sand Dollar is the world's first country-issued CBDC. It was launched in October of 2020 by the Central Bank of the Bahamas. One year later, the eNaira was launched by Nigeria.

The ECCU has been in existence since 1965. It introduced the East Caribbean Dollar (EC) as the shared currency of its member nations. The EC is pegged to the US dollar.

Benefits & Challenges of Adopting CBDCs

The concept of a digital currency presents a way for sovereign nations to offer their citizens the efficiencies in cost and timeliness that a digital currency can offer while maintaining central control over those currencies and providing greater security than cryptocurrencies. Since a digital currency would have a broad impact on a country's businesses and population, governments are taking the time to study the concept closely and making sure that they have considered the full implications such a move would have.

Benefits of Central Bank Digital Currencies

The following benefits of a CBDC are specifically mentioned in the Fed's CBDC document:

  • Safety: A CBDC would be free from credit and liquidity risk.
  • Improved Cross-Border Payments: Cross-border payments could be streamlined and new opportunities could emerge for cross-country collaboration.
  • Support for the U.S. Dollar's International Role: A CBDC would help preserve the role of the US dollar as the dominant international currency.
  • Expand financial inclusion: A CBDC could provide economically vulnerable households and communities with greater financial access.
  • Extend Public Access to Safe Central Bank Money: A CBDC would provide another means of payment for the general public with the same safety as the dollar.

Additionally, a CBDC could be created without the huge energy requirements necessary to create many cryptocurrencies and it would also potentially enhance transaction efficiencies and lower costs.

Challenges of Central Bank Digital Currencies

The Fed also noted the following challenges for a CBDC:

  • Structural change: A CBDC could fundamentally change the structure of the U.S. financial system, altering the roles and responsibilities of the private sector and the central bank.
  • Threats to safety and stability of the financial system: The ability to quickly convert other forms of money into CBDC could make runs on financial firms more likely or more severe.
  • Efficacy of monetary policy implementation: A CBDC could impact current rules and policies of the Fed with regard to implementing monetary policy.
  • Privacy, data protection, and crime prevention: A CBDC would need to strike an appropriate balance between safeguarding consumer privacy rights and affording the transparency necessary to deter criminal activity.
  • Operational resilience and cybersecurity: Operational disruptions and cybersecurity risks would represent a concern.

Investing in CBDCs

CBDCs do not offer the investment opportunity that may exist with some cryptocurrencies. Since CBDCs are pegged to an existing physical currency, investing in them would equate to investing in the underlying currency itself and thus offer no particular investment value other than the ability to take advantage of 'currency arbitrage'. This type of arbitrage trading is conducted by some institutions and hedge funds but is not considered a practical strategy for individual investors.

Bottom Line

The introduction and widespread adoption of cryptocurrencies in recent years has influenced central banks around the world to consider developing CBDCs to complement their existing physical currencies with digital currencies of their own, over which they would exercise control. CBDCs are thus seen by central banks as a way to enhance the monetary efficiency of a physical currency by itself in addition to maintaining control over the digital currencies being used by its population.


  • No. Cryptocurrencies are not backed by any banks or government entities.

  • CBDCs are backed by central banks and pegged to a physical currency. Bitcoin is a cryptocurrency with no central bank support and no peg to any physical currency.

  • Decentralized finance describes financial activities and transactions that occur directly between and among relevant parties and exist outside the purview of central banks or other government entities.

  • Not necessarily. They can be created on a blockchain infrastructure, but other ways of developing CBDCs are being investigated.

This article was written by

Richard Lehman profile picture
Adjunct Finance Professor at UCLA and UC Berkeley (18 yrs), author of three investment books, Wall Street veteran and founder of Informed Assets, PBC. Helping people understand and invest in equities, options, and alternatives such as Cryptos, NFTs, collectibles, private equity, real estate, venture capital, etc.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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