TLDR: A Central Bank Digital Currency (CBDC) is a digital currency issued by a country’s central bank. Its value corresponds to the physical currency of the issuing country, and just like physical cash, it is not backed by an external commodity such as gold or silver. Rather, the public’s trust in the issuing country and its monetary policy — like how much is issued and interest rates — set the value of CBDCs and physical currency. Central banks fix the value of CBDCs, which always equals the value of the country’s physical currency.

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In the last six months, people have been really getting into central bank digital currencies (CBDCs). The ongoing banking crisis, surge in inflation rates, regulatory uncertainties surrounding digital assets and the thought-provoking debates triggered by crypto winter have all contributed to the worldwide interest in alternative money systems.

The Bahamas, Nigeria, and China are among countries that have already launched CBDCs. Other pilots are under consideration, like the European Central Bank’s and the Bank of England’s digital pound — or, as it’s nicknamed, Britcoin. (Sidenote: I’m surprised Britney Spears’ superfans haven’t gotten there first and turned the popstar's name into meme coin!)

The U.S. is undecided on CBDCs, but in 2020 the Federal Reserve released a whitepaper on its understanding of and position on CBDCs. The central arguments in favor of CBDC’s were: declining use of cash, expensive and complex financial infrastructures, financial inclusion, and the need to innovate amid the banking crises. However, a number of critics argue a CBDC would jeopardize consumer privacy rights.

While countries deliberate on how to best implement digital cash, it's important for consumers to understand the basics of how CBDCs work.

CBDC basics

CBDCs come in two categories: retail or wholesale.  Retail CBDCs are for individuals and businesses to transact with each other. Wholesale CBDCs are for banks and institutions to settle transactions between each other. 

But wait, isn’t money already digital? 

Yes, we confirm our bank balances on mobile apps, use Apple Pay to buy things, and, especially in the US, many of us already operate a cashless existence (we see you, card-only coffee shops!). But it’s financial infrastructure that makes that digitization possible, not digital money itself.

What do we mean? Unless you’re paying for your coffee with crypto, every digital banking transaction is made possible by digital credit models and/or fintech that tracks digital transactions between institutions and makes the accounting systems interoperable with balance sheets at the banks. It's not as though your dollars are physically moving from the bank to the coffee shop each time you buy a latte, but rather software settles the world's infinite transactions, making sure the assets on every bank's balance sheet are, at the end of the day, backed by fiat currency.

This worldwide double-entry ties into one of the chief arguments in favor of CBDCs: reducing costs of complex global financial systems. A digital infrastructure for a hypothetical $USCBDC would centralize digital payments and transfers, rather than requiring digital payment providers to talk to each other from different merchants. The U.S. digital banking and commerce system could arguably become one nation-wide digital ledger. 

Where does the central bank fit in?

Central banks control the money supply and how much money is printed. They also serve as a last-resort lender to bail out instutions that would collapse the nation's economy if they were to go under.  Do you remember 2008 and the mantra of too big to "fail"? When the U.S. government bailed out the big banks, it was the Federal Reserve — the central bank of the U.S. — that provided the cash. The Federal Reserve also sets interest rates — the cost of borrowing money — as a means to control inflation. When interest rates are raised, it’s because inflation is high. Low interest rates typically signal a time of economic boon.  

Questions remain around the institutional, retail investor, and consumer demand for CBDCs and whether the resources required to develop them will be worth it. A digital currency is also traceable and therefore more easily taxable, which could make voluntary consumer adoption of CBDCs less likely. 

CBDCs vs. fiat vs. stablecoins

Strictly speaking the definition of “fiat" money is “a currency backed by the government that issues it. That definition doesn’t rule out a digital possibility. Still, so far in Web3 conversations, “fiat” as a term has typically been reserved for the official physical currencies issued by governments, like $USD. 

Are CBDCs stablecoins? No, but they’re similar! Like stablecoins, CBDCs are pegged to an outside currency and their value will be fixed to that asset in perpetuity. CBDCs, however, do not operate on a public, permissionless blockchain as they are issued by central banks. They operate on permissioned blockchains. Stablecoins are issued by private entities and operate on public, permissionless blockchains. Ironic, we know.  It is also possible to launch a CBDC that doesn’t even operate on blockchain, like Jamaica's JAM-DEX. Depending on who you ask, CBDCs aren’t cryptocurrencies because 1) they’re not issued privately and 2) they don’t necessarily need to be on a blockchain. 

CBDCs are centralized, whereas most cryptocurrencies are decentralized — or aim to be. CBCDs are not DeFi. Stablecoins that are linked to the US Dollar, such as $USDC, are not CBDCs because they are not issued by the Federal Reserve. 

Why are governments exploring CBDCs?

So if CBDCs are not necessarily crypto in the most specific sense of the word, why are governments interested in them? There are a few reasons:

1. Cash is no longer king (nor queen): Cash usage is down, declining especially during the pandemic. When cash is not as used, that leaves room for privately issued digital currencies to take wallet share. Central banks need government issued currencies to be highly adopted. So if behaviors trends toward digital assets, arguably central banks must follow. 
2. Need to innovate: The same way money has become increasingly digital in the last three decades, money has become increasingly privatized. Central banks are not innovating at the speed of the private sector. CBDCs could allow them to gain a competitive advantage and thus more consumer and citizen participation, strengthening the value of the CBDC and fiat money overall. The current banking crises are perhaps brewing distrust in private institutions and central banks may need to seize this opportunity. A CBDC is a good way to do that but does it give governments too much control? A concern that permissionless blockchain-based digital currency - cryptocurrency - was built to alleviate. 
3. Globalization is expensive and complex: Increased globalization of the economy likewise means an increasingly complicated and expensive global payments systems for institutions and consumers. CBDCs could help central banks and their governments regain control and influence over local payment systems, which is especially important in less developed countries. Especially in times of economic crisis, remittance tends to be high - working in one country’s currency but sending it to another country. This is expensive and complicates monetary policy for both nations. 
4. Financial inclusion: People working or operating in cash are more likely to be unbanked or feel underserved by existing financial institutions. CBDCs and a nationwide digital ledger give those who operate in CBDCs a digital financial home. Certain professionals working in cash are also potentially excluded from private online banking platforms. 

Conversely and rightly, there are concerns about alienating those who prefer — or can only operate in — physical cash and alienating them from participating in financial systems if CBDC were to replace physical cash. This is a similar argument against card-only  businesses, given that fiat cash is legal tender. Remember when Sweetgreen had to abandon its much loathed cashless policy in 2019? Many governments are maintaining now that CBDCs would not replace physical cash but there are no guarantees. 

CBDCs are also traceable and could arguably give central banks and governments more unmetered visibility into citizens’ transactions and identities without the barrier of private institutions and platforms. 

“[CBDCs] are a hot topic due to the awareness of digital currencies and government controls and overreach,” says Trustars Entrepreneur in Residence Laura Walsh. “This also raises the question of barriers to access. The elderly, disabled, and the economically depressed don’t have the tools, know-how, or sometimes technology to use digital cash. Personally I feel there should ALWAYS be an option to use cash.” 

Attitudes among Web3 and crypto purists are on a spectrum. Some feel governments’ participation in digital assets will increase mass adoption while others feel a government backed digital currency contradicts the primary use case of cryptocurrencies, which are always on blockchain. Cryptocurrency is rooted in trust in blockchain over trust in institutions, like central banks or governments. Those of this mind could see CBDCs as a threat to mass adoption of Bitcoin or other privately-issued cryptos. 

Some experts see CBDCs as a potential positive step toward legitimizing the digital asset class, including blockchain-based cryptocurrencies. 

The reality is, like with many things in Web3, likely somewhere in the middle and it remains to be seen. 

“CBDCs represent firstly a recognition by authorities of the underlying technology use case. Concerns have been raised with limitations on access to this technology and whether this can/should be entrusted to central government and whether this will further negatively impact financial inclusion and privacy,” says Paige Berges, Specialized Financial Crime/Sanctions Counsel at law firm Ropes & Gray.

Bottom line

• CBDCs are central bank digital currencies. They are backed and controlled by central banks of issuing governments.
• CBDCs always equals the value of the country’s physical currency and can operate on or off a blockchain. On blockchain CBDCs are operated on a permissioned blockchain unlike true cryptocurrencies. 
• They are not stablecoins. Stablecoins are issued privately and on permissionless blockchains. 
• Governments are exploring CBDCs are a means of financial inclusion, innovation, reducing cost and complexity in financial systems, and localization during tough economic times. 
• China, Nigeria, and the Bahamas have launched CBDCs. Europe, the U.K. and the U.S. are considering it. 
• Pros to CBDCs also present cons: financial inclusion vs. exclusion; privacy vs. traceability and questions about government control and trust. 

Further Resources:

IMF: Interest in Central Bank Digital Currencies Picks Up in Latin America and the Caribbean While Crypto Use Varies

Reuters: Limited support for central bank digital currencies

Blockchain application for central bank digital currencies (CBDC)

Money and Payments: The U.S. Dollar in the Age of Digital Transformation

Bank of England: The digital pound

I Also Want Money Podcast: Risk & Regulation in Crypto with Paige Berges

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‍This is not financial advice. If you don't want to spend money investing in crypto or Web3 — you don’t have to. The intent of this article is to help others educate themselves and learn.

Nicole Kyle is a storyteller, podcaster and gender equity advocate exploring the intersection of money, equality, technology, and creativity with a focus on crypto & web3 education.  Nicole is a 2022 LinkedIn Top Voice in Gender Equity and a Public Voices Fellow on Advancing the Rights of Women and Girls with The OpEd Project and Equality Now.